Tuesday, July 18, 2006

End of the global economic boom?

Dr. Marc Faber addresses this topic in a recent MoneyWeek article entitled, "Why an inflationary bust is inevitable".

Here Faber discusses the role that liquidity played in creating this boom, and the idea that slowing this liquidity growth may bring about further declines in asset markets.

Aside from the Middle East, it is apparent that liquidity conditions around the world, while still expansionary, are less expansionary than in the 1999–2005 time frame.

Now, whenever central banks create excess liquidity, symptoms of inflation will show up somewhere. Sometimes wages and consumer prices will react the most to expansionary monetary policies (for example, the 1960s and 1970s), but in today’s world where, given the low wages in China and India, an almost unlimited labour arbitrage can take place, easy monetary policies drive asset prices such as homes, commodities, equities, art, and so on, higher, while wages and consumer prices rise only with a lengthy time lag (once commodity prices begin to be passed on in the prices of finished manufactured goods).

Therefore, it should come as no surprise that, when liquidity growth is slowing down, asset prices begin to cave in first.

I'm looking on and Faber admits to shifting his views a bit, at least with respect to the scenarios he has outlined in recent writings. This will require a careful read:

But, as I have repeatedly pointed out, it usually pays to listen to the market. And in this respect, we should take rather seriously the sharp break in equity and commodity prices, as well as in some of the emerging market currencies, that we experienced in the second half of May. The break may prove to be only of very brief duration with new highs to follow, but the impulsive nature of the break suggests differently — at least for now.

Naturally, investors will immediately ask why stocks and commodities should sell off when we are in the midst of a global synchronised economic expansion, when corporate profits are still expanding. The point is that, precisely because we are in a global boom, liquidity is likely to become tighter for a while and that, as just outlined, in such an environment equities and other asset prices are vulnerable until liquidity conditions improve once again.

But don't go by my selective quoting; to appreciate the full range of Faber's reasoning, make sure to read the full article for yourself.