THE
BEAR'S LAIR BRICs coming
unstuck By Martin Hutchinson
The 2008-9 recession centered on the
wealthy Western economies, with emerging markets
suffering significantly shorter, less painful
downturns. Then in 2009-11 the emerging markets,
particularly the BRIC countries (Brazil, Russia,
India and China - so named by Goldman Sachs' Jim
O'Neill in 2001) soared ahead of the wealthy West,
leading to considerable talk of global economic
realignment. However, as we enter the second half
of 2011 new doubts have emerged: are the BRICs
overheating, and will they cease bringing growth
to the rest of the world? (South Africa joined the
grouping earlier this year.)
There has
been a great deal of talk in the last few years
that the Brazilian and Indian models of
center-left social democracy could
show the world that
democracies with left-of-center governments were
as efficient as truly free-market administrations
in generating growth. This column has warned on a
number of occasions that the media admiration for
both countries' economic management was foolish,
but until very recently this warning, like a
number of this column's doom-laden forecasts,
appeared to have been overstated.
Now as
often happens it is beginning to appear that the
Bear may merely have been premature. Brazil in
particular looks to be in deep trouble. Under
president Luiz Inacio Lula da Silva the country
had an interesting mixture of an excellent
monetary policy and an inferior fiscal policy,
with interest rates firmly positive in real terms
while the government persistently overspent.
The fiscal problem was masked for a number
of years by the relentless global increase in
commodity prices, which improved Brazil's balance
of payments and allowed its public debt position
to improve significantly as export revenues
surged. Inflation, which would normally have
become a serious problem in such a situation, was
tamped down by the very high interest rates and
the consequent strength of the real.
Then
in 2010, as is often the case with center-left
governments who have got lucky with the economy,
Lula overdid the spending, as he attempted to
secure election for his protege Dilma Rousseff.
Not only did the official budget deficit widen by
about 2% of gross domestic product (GDP), but the
development bank BNDES went on a lending spree and
the state corporate sector went wild with losses.
The position was made to look respectable
by the government extracting US$50 billion from
the unfortunate Petrobras, through selling the
same oil reserves to it twice, but in reality
overheating was inevitable, however sound the
central bank's monetary policy (12% interest rates
- my kind of place, monetarily speaking).
Rousseff has made only feeble attempts to
control public spending and has shown signs of
meddling in Brazilian industry far beyond the
official government companies, playing favorites
recently in a retail takeover bid. Now Brazilian
consumer borrowing is out of control, with
consumer debt service at 28% of disposable income,
compared with 16% in the US at the height of the
2007 credit bubble.
Admittedly, high
Brazilian interest rates (a mean 47% on consumer
borrowing) make debt service greater than in the
US for a given amount of debt, but even so it
seems likely that with both government and
consumers overspending, Brazil is due for the
father and mother of a credit crunch.
India's problem is in many ways similar to
Brazil's. Like Brazil, it elected a center-left
government in 2004, which has remained in office
since, benefiting from the long boom caused by its
predecessor's market-opening policies. Like Brazil
only to an even greater extent, the Indian
government failed to control public spending
adequately. As a result, India has for a number of
years been running public sector deficits of
around 10% of GDP, when you include both national
and local governments.
India's other
problem is that its economy is structurally the
other way around from Brazil's, being a massive
importer of commodities and exporter of
manufactured goods. Consequently, when commodities
prices rise as at present, its balance of payments
deficit tends to worsen and inflation tends to
rise. Its wholesale price inflation rose to 9.06%
in May, year-on-year, and a poor monsoon is
expected to re-ignite the flames of food
inflation, which had been quiescent over the past
year. The Reserve Bank of India has raised
interest rates 10 times, but its benchmark rate is
currently 8.2%, still well below inflation, as is
the 8.5% yield on Indian government bonds.
Indian growth slowed in the first quarter
to a year-on-year rate of 7.8%. That's still
magnificent, of course, but with the government
overspending and the economy still largely subject
to the inefficiencies of the "permit raj" a hard
landing is much more likely than a soft one.
The Chinese government thinks it has
inflation under control and that it has touched
the brakes effectively on the country's runaway
economic growth. Since official inflation is only
5.5%, it would appear at first sight that China
has little to worry about. The problem in China is
that official figures are not to be trusted, so
that an official inflation rate of 5.5% may
translate into a real figure of 10%. That still
would not be enough to get too concerned about,
given China's spectacular growth rates, except
that Chinese short-term interest rates, even after
six rate increases, are still at only 6.46%.
The problem people really worry about in
China is the level of bad debts in the banking
system. These were estimated at $911 billion by
Ernst & Young as long ago as 2006 (in an
estimate they later withdrew under pressure from
the Chinese government) but have undoubtedly been
much enlarged by the subsequent real estate boom
and the "stimulus" lending, mostly to more real
estate, which the government encouraged in 2009 -
yet another foolish Western import the Chinese
government must now regret.
The People's
Bank of China now estimates that local governments
alone owe about $2.2 trillion - a high proportion
of which loans must now be bad, since much of the
lending was devoted to the foolish "stimulus" of
2008-09. Add in the debts of real estate
developers, secured against the vast empty
apartment and office blocks that dot the cities of
inland China in particular, and the debts owed by
the remaining state companies, most of which
operate at a loss, and the total of bad debts in
the Chinese banking system may be as high as $5
trillion, in other words 100% of China's GDP and
more than 50% greater than its much vaunted
foreign exchange reserves.
Of course, as
in most such situations, not all those debts will
be completely worthless, but it appears likely
that China has a bad-debt problem that in terms of
its economy is considerably larger than the US
mortgage debt overhang of 2008.
With
"true" public debt probably around 100% of GDP,
the country seems likely to fulfill the criteria
set out in Kenneth Rogoff and Carmen Reinhart's
magisterial book This Time Is Different for
a serious banking crisis that produces an
intractable recession, probably involving
below-par economic growth for a decade or more.
China seems to be in very much the same position
as Japan in 1989, apparently invulnerable but in
reality heading for a very large crash indeed. It
does not make it easier that, unlike Japan in
1989, China has not yet attained Western standards
of living, except for a relatively thin slice at
the top.
Finally, Russia never really
deserved to be put on a list of emerging growth
markets at all, although when O'Neill coined the
acronym in 2001 Vladimir Putin's "flat tax" income
tax reform had produced a burst of economic
growth, and it appeared that the country's natural
resources would produce rapid income gains as they
were exploited by a combination of international
majors and domestic entrepreneurs.
Needless to say this did not happen.
Although the increase in oil prices produced
growth, Russia's economy by 2008 was in little
better shape than Venezuela's, with business
suppressed (and in some case imprisoned) by the
government and resource revenues squandered by a
government greedy with corruption and Putin's mad
revanchist ambitions.
Since 2008, Russia's
position has somewhat improved. President Dmitry
Medvedev is at least marginally less nostalgic for
the Soviet Union than Putin, and has some
understanding of the need for Russia to develop a
proper private sector. Unfortunately, the private
sector Russia has now is of very poor quality,
with oligarchs in control and a short-term
orientation even more extreme than that of the
average Wall Street hedge fund. The effective
collapse last week of the Bank of Moscow, the
country's fifth-largest bank, is symptomatic of
the rot in the system.
Were Medvedev to
win next year's election and sideline Putin, there
might be some chance of economic reform which, if
lubricated by continued high oil prices, could
produce a generally sound and growing economy. As
it is, that must be reckoned unlikely, and the
greater balance of probability is that Russia will
join the other three BRICs in economic crisis at
some point in the next year or so.
Outside
the BRIC economies, there are signs of hope. Japan
is in better shape than many people believe, while
South Korea, Taiwan, Singapore, Chile and Colombia
are well run and should continue to thrive. Then
there's Thailand, which this month can rejoice in
a thumping election result and a new leader,
Yingluck Shinawatra, even more pulchritudinous
than Sarah Palin! In Europe, Germany is thriving
and Sweden appears to need only a modest tap on
the monetary brakes.
Nevertheless, for the
last three years, with much of Europe in economic
disarray and the US locked into what seems likely
to be a decade-long economic downturn, the world
had become very reliant indeed on rapid growth in
the apparently invulnerable BRICS.
Turns
out, the BRICS weren't invulnerable - and the
world will have to look somewhere else for a
growth engine.
Martin Hutchinson
is the author of Great Conservatives
(Academica Press, 2005) - details can be found on
the website www.greatconservatives.com - and
co-author with Professor Kevin Dowd of
Alchemists of Loss (Wiley, 2010). Both are
now available on Amazon.com, Great
Conservatives only in a Kindle edition,
Alchemists of Loss in both Kindle and print
editions.
(Republished with permission
from PrudentBear.com.
Copyright 2005-11 David W Tice &
Associates.)
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