Hot Money Woes

I was asked if the growth rates I referred to in my post on commodities were still valid.

I thought about it for some time and came up with this:

If policymakers in the China, India etc. act as they should and mop up excess liquidity and reel in inflation, we'll see growth hit a short term snag and a correction in commodities prices. The longer term forecasts will still hold though and economic growth and commodities prices should begin to takeoff shortly after. In fact, I wouldn't be surprised if this type of cycle repeats itself, since as I've posited below, supply won't come online fast enough.

The IMF published a couple feel-good pieces on how policy makers should respond to inflation and the credit crunch, which they identify as the main threats to growth.

http://www.imf.org/external/pubs/ft/survey/so/2008/POL050808A.htm http://www.imf.org/external/pubs/ft/survey/so/2008/RES040908A.htm

Simple enough in words, but politicians are biased toward growth and loose monetary policy (an unemployed constituency is an unhappy constituency). Also, considering that most central banks in the developing world are not nearly as independent as the Fed, we may not see the requisite policy actions taken.

Thus, a caveat, a pretty extreme one actually, to what I asserted about commodities.

Monetary policy has been extremely loose in China, LATAM, and almost everywhere else over the past few years (the looseness is relative - interest rates are higher in all these countries than in the US, but they all have negative real rates, which is a better indicator of how stringent monetary policy is). And due to the the US's patterns of consumption and low interest rates, dollars have been flooding developing nations.

This article from the Economist does a good job of describing how this has affected China recently.

With all this hot money floating around, inflation is inevitable. and with central banks unwilling to let their currencies appreciate or raise interest rates further, inflation may continue unabated. As a result, we may very well see a devaluation of all these currencies, a la 1997. This would severely cripple developing world economies and any accompanying growth story.

Take vietnam for example. YoY growth there was 14% but inflation has now hit 25%. Last year the Vietnamese central bank was worried about keeping the dong from appreciating. Now it is fending off a severe devaluation, as futures markets predict a 30% fall in the dong (http://www.cnbc.com/id/24999862/).

Burn!