A year of stagnation continued in 2013: Andy Xie

Both developed and emerging economies will see lower growth.

BEIJING ( Caixin Online ) — Between 2009 and 2011, the emerging economies, especially the BRICs, kept growing following a brief crash in 2008. Many pundits interpreted it as a sign of decoupling. Emerging economies, due to their low base, tend to grow faster than the developed ones. The issue is by how much. We read this article on Marketwatch by Andy Xie.

During the 2009-11 period, they experienced high inflation, debt growing faster than income, and asset bubbles, not signs of sustainability.

The growth spurt was due to a hot money bubble rather than a natural state of affairs. This bubble isn’t blowing up like in 1997 because the big central banks are still loosening monetary policy. Hence, this bubble could deflate gradually.

A bubble deflates when it can’t expand, even if there is no trigger to deflate it. The weight itself can bring it down. Even though the Fed, European Central Bank and Bank of Japan continue to expand money supplies, the incremental changes are smaller than before.

On the other hand, the asset bubbles in emerging economies have become big and demand acceleration of hot money to continue. The contradiction is causing the emerging economies to cool.

The statistics in emerging economies are not accurate. The gross domestic product data in China and India, for example, do not reflect their 2012 slowdown. My estimate is that the growth rate in emerging economies declined by half in 2012 from 2011. It could be seen in trade stagnation and weak commodity demand.

China and India

When an emerging economy has a low stock of capital and surplus labor, like India, inflation tends to be associated with supply bottlenecks and commodity inflation. China was like that a decade ago and India still is today.

China was able to invest massively to de-bottleneck and join the World Trade Organization to create demand. The policy combination led to a decade of rapid growth. Now, China has exhausted growth potential from surplus labor, infrastructure formation and rising export penetration.

For the next wave of growth, it needs to shift to labor productivity through improving quality and technology on the supply side, and consumption on the demand side. Even if the transition is successful, the growth rate would be much lower than in the past, possibly only half as high.

India faces terrible trouble in expanding supply. The constraint is problems in investment implementation, not capital. The global cost of capital has declined sharply with slowing growth everywhere.

If India can show ability to form capital like China, global capital would pour in for the upside. Even though the global financial community has been hyping the India story, trying to drum up more business, the multinational corporations (MNCs) have not been able to invest much. Those that have, have had a pretty bad experience.

Even though India has potential, it will remain so for years to come. Hence, it is not going to take from China to become a growth engine. This is important for commodities. As China’s demand cools, suppliers are pinning their hopes on India. They will likely be disappointed. Industrial commodities will likely continue to decline in 2013.

The China-India story is vital for the global growth outlook. If they can’t deliver more, the global economy will remain stuck. The Organization for Economic Cooperation and Development (OECD) economies are not capable of good growth under the best circumstances.

Aging and declining competitiveness hold them close to zero growth in per capita income. The debt problem is an added headwind. The relatively low growth rates in China and India will last for years to come, I believe.

Death of debt-led growth

The global economy has seen debt growing faster than income for the past decade. It is obviously not sustainable. After the 2008 global financial crisis the pattern has continued with debt formation shifting to the government. Now the fiscal crisis is engulfing Europe, Japan and the United States. Government debt can’t grow fast in the future.

The Fed isn’t giving up on the debt model. Through quantitative easing (QE), it is artificially depressing the cost of borrowing. Corporate debt issuances have skyrocketed. But businesses cannot create final demand. Bonds are really replacing more expensive equity capital. It is a substitution that won’t do much to final demand.

The latest Fed QE is putting mortgage borrowing on sale. Its cost is at a historic low. The U.S. housing recovery is largely driven by that. Putting borrowing on sale may not work if debt is already too high.

U.S. household debt is down 7% from the peak that triggered the financial crisis. By the historic norm, the current level is still too high. Also, debt demand depends on one’s income expectation. American workers have low income expectations. Making them borrow more isn’t likely to be effective.

China’s debt problem is the opposite of that in developed economies. The leverage is mostly with businesses and local governments. China’s companies have debts twice as high as the international average, but less than half of the profitability. The leverage has been dependent on land appreciation.

As the land bubble deflates, a business debt crisis has already begun. It doesn’t burst like the United States’ subprime bubble because Chinese banks roll over the delinquent loans. Still, debt could hardly be used to boost growth again.

Stagnation continues in 2013

The fiscal consolidation among developed economies will keep their growth rates in 2013 lower in 2012. Europe and Japan will probably have zero growth, plus or minus half a percent. The United States may have 1.5% to 2%, depending on how much fiscal consolidation unfolds during the fiscal cliff and debt ceiling negotiations. The OECD block may see a growth rate of 1%.

Emerging economies will likely grow between 4% and 5%. It will be seen in similar growth rate in dollar trade value. I think this outlook is optimistic. My bias is that it would be worse. The market is expecting a significant improvement in 2013 from the depressing 2012. I think otherwise. Indeed, we need to get used to low growth rates in the future.

Growth stimulus has been a mistake. The low growth isn’t just an outcome of the debt crisis. It reflects structural forces that will keep growth low for years. The growth spurt in the last decade is largely due to integrating Chinese labor into the global economy.

The information technology revolution also contributed. Both forces are spent. Nowadays, the IT revolution is more about destroying first than creating later. The net growth impact is likely small.

Instead, policy-makers should adjust their policies for a slow growth environment. The growth stimulus merely brings financial buzz in the short term, which makes some people happy, but at the expense of balance sheet health. Eventually, inflation blows up, which would cause worldwide political turmoil.

Some predictions

Last year I was bullish on the stocks of MNCs and precious metals, and bearish on industrial metals and emerging market properties. My hunches for 2013 are similar, with a few changes.


1) MNC stocks. MNCs are the biggest beneficiaries of globalization. Their global footprint allows them to manage costs and demand fluctuation in any one place. They have used their profits to build up intellectual properties, brands and scale.

The entry barriers are very high at the top. This is why their profits have remained good despite all the crises around them. Their stocks gained sharply in 2012. Hence, the gains in 2013 may not be as spectacular. Still, in a low growth era, stable earnings will be highly valued.

2) Gold. Gold performed poorly in the second half of 2012. Rupee (ICAPC:USDINR)  devaluation has sapped Indian demand for gold. The dollar has been strong. Competing assets like stocks and bonds have done well, draining its investment demand. Still, it has remained resilient.

Gold is a hedge against monetary inflation. Inflation is inevitable to solve today’s debt crisis. When the market realizes that the Fed wouldn’t pull money back to fight inflation, gold will go very high. The final surge is likely in 2014, not next year. Still, it could reach a new high in the second half of 2013.

3) Bonds. Central banks are manipulating interest rates along the whole yield curve. They will continue to do so as long as inflation isn’t a big problem. The bond market is a bubble, but there is still time to play.

I suspect that 2013 will still be a good year. Along the same line, I’m bullish on U.S. banks. What the Fed is doing to the property market will benefit them enormously. The bond bubble will burst when inflation becomes indisputable, which is likely in 2014.


1) The yen. I wrote an article on the turning point for the yen in early November. Even though the yen has dropped sharply since, it has a long way to go. The yen-U.S. dollar exchange rate may break above 100 in the second half of 2013.

With fiscal consolidation inevitable and the economy in recession, Japan has nowhere else to turn. Some people argued with me about the yen. They said that not only Japan, but everyone else, needed devaluation. The difference is that yen has been appreciating despite Japan’s recession. The reversal brings it in line with others.

2) The A$. The Australian dollar may tumble over 10% in 2013. The Australian economy is not in good shape due to the strength of its currency. It lives on the commodity boom and a property bubble. The recent recovery in iron ore and other industrial commodities is a head fake.

The commodity boom is over. The investment boom in the sector will lead to oversupply for years to come. Along the same lines, industrial commodities will do poorly again. The price of iron ore will likely reach a new low in 2013.

3) Emerging markets. Stocks and properties in emerging market will again fare poorly in 2013. They need to absorb the impact of a deflating hot money bubble. They are behind developed economies in debt and bubble adjustment.

Companies in emerging economies have few inherent competitive advantages to protect earnings on the way down. Indeed, on the way up, they depend on asset inflation for earnings. This is why banks and property companies tend to lead emerging markets. When the cycle turns down, no one does well.

4) Bullish on agriculture. The degradation of farmland in China will remain a major force driving up the prices of agricultural products. As food safety becomes a central policy issue in 2013, the impact becomes bigger. In a down cycle, food consumption is resilient. The demand and supply balance favors the agro market again.

Every year I write down some thoughts on the markets. Economics says that markets are unpredictable. Nevertheless so many of us still try.

I try to make predictions on extension and collapse of irrational forces. When a government or central bank understands something wrongly and acts accordingly, it drags the market along until it hits a wall.

A herd mentality is another force. It is usually potent in emerging economies. Betting on governments and people acting foolishly seems a winning strategy, at least in the short term.