PERCEPTION and the Need For Greater Global Policy Coordination in a 2014 WORLD

Posted on February 4, 2014. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , , , , , |

Perception is a major factor driving volatility in the market and this is why I am of the firm opinion now that it’s the market psychology and the overall investors sentiment aka the “mood of the markets” that creates and drives the volatility. And when a perception starts getting entrenched then people generally tend to ignore the sense of reasoning and stop looking at the big picture and this is why at times markets tends to behave like headless chickens because the underlying perception creates uncertainty and CHOAS takes over. So it is important to arrest this momentum before it ends up damaging the economy, it’s like this…we create a perception and then use that perception to create a reality.

In an interconnected global economy perception can create volatility and uncertainty and this is one of the reasons why a contagion risk remains a plausible scenario especially when people tend to get overwhelmed by the sound bites coming from various quarters of the financial markets. But it must be said that there is always value in looking at each market and economy individually. For instance, if we look at Turkey and Argentina, the fundamentals of these economies didn’t really deteriorate overnight. The Turkish central bank should have raised rates over a year ago but today the stretched fiscal situation combined with the political uncertainty is hurting the economy real bad but having said that a quick political resolution will likely calm the fears around Turkey and with regards to Argentina, the central bank of the country has been running a wacko monetary policy for sometime now so what the country is facing today is an outcome of such policies.

And assuming the worst case scenario, both Argentine and Turkish economies isn’t big enough to possess a systemic or a damaging contagion risk for all the emerging market economies, at least not based on the ground realities but yes in perception there might be. And to get some perspective, it is worth remembering that both Turkish as well as Argentine economies have gone through crises in the past without causing any significant problems for the world economy and also the rest of the EM didn’t really see any damaging contagion  come through and that’s the reality. Also, it is important to note that economies both in EM as well as developed markets tend to be at a different levels of maturity and they are different in many ways. For example, China and Brazil although a part of the same block of BRICS nations are in fact two different economies in many ways. The leadership in China for instance needs to implement the planned financial reform agenda whereas Brazil clearly needs a wholesale supply side reforms. So in short they aren’t dealing with the same issues.

We live in a very interconnected 24 x 7 world where perception drives the overall investors sentiment creating volatility and the global economy of 2014 reflects that reality. Perception can have a snowball effect and is no doubt contagious. So even though the IMF has revised up its global growth projection for the year 2014, there are a number of factors that could influence the real economic growth going forward. And one of them is a possible decline in positive sentiment and confidence in general around the global economy driven by a change in overall perception. And in most likelihood a potential sluggish growth and deteriorating fundamentals across emerging markets will have an impact on the overall growth dynamics of the developed world so it will be unwise to assume that the developed markets are going to be somehow immune. This is why it will be ill-advised to conclude that the developed markets have entered a self sustaining growth in 2014 so when I hear the sound bites coming from parts of the markets suggesting that the current volatility in the market is more or less an emerging market issue and thus the policy markers in the EM should get their house in order by adjusting to the market expectations, I can’t help but wonder, are they seriously suggesting or assuming that the developed world can grow in isolation especially in a post financial crisis world and also that the turbulent cloud over the emerging markets won’t enter the developed world? The markets clearly believe that a potential turmoil in the developing world could have an effect on the developed world. And there is probably a strong reason behind  that assumption.

When the western economies were on the verge of collapsing during 07/08 crisis, the politicians and the policy makers were busy calling anyone and everyone including their counterparts in emerging markets to help the global economy get out of the mess and most emerging markets did come together and a global policy coordination was worked out to keep the world economy going and from falling under. To help safe the financial sector and the economy, the central banks adopted an ultra loose monetary policy and there is very little doubt that part of the current volatility in the EM is driven by this ultra loose monetary policy adopted by the central banks in the developed world. So clearly, the EMs are dealing with the side effects of QE. The hot and easy money that flowed into various emerging markets chasing yields created asset price distortion. So the fundamentals of the emerging markets were known to the investors while they flocked into EM chasing high returns but now that the supply of hot money flow is being cut, the worry is that the real ground on which they were standing will get revealed.

Generally investors tend to invest in emerging markets attracted by the growth story but GDP numbers shouldn’t be the only indicator when considering an investment opportunity. In theory, we can measure GDP using three different approaches. 1 – overall production approach, 2- overall expenditure approach, 3- and the overall income approach but none of these 3 approaches can fully and comprehensively report or record the overall economic activities or output of a country let alone the world. High growth in a high inflationary environment creates distortion and isn’t really a sustainable growth model. And here is why, entrenched Inflation in the developing world tends to destroy disposable income and living standards and the idea that somehow high growth could fix everything in the long run doesn’t really hold water. In short, strong GDP growth numbers isn’t necessarily a one way ticket to prosperity because high growth creates various types of unforeseen problems and challenges so any growth model has to factor the exponential function rules, for example a 10% growth rate year-on-year means the economy will double in just 7 years and doubling of the economy isn’t just all positive. So any sustainable economic growth model will have to factor in a period of adjustment to allow for consolidation.

An economic journey isn’t about just about speed at which a country can reach from point A to Z quite simply because there is no Z or in other words there is no final destination but targets  to help deliver overall progress. A sustainable economy will have to keep evolving every 5 years or so to remain relevant and this is where the challenge lies for the global economy. By design, the global economic model along with the existing structure of the financial markets are less than efficient and this is why every now and then we find ourselves in a CRISIS. For example, today while the developing world is struggling with inflation, the developed world would love to have some of that inflation in the system.

And the ultra loose monetary policy has so far failed to deliver inflation in the developed world. Also though the tapering of quantitative easing (QE) by FED which I must say is inline with my own expectations ( not that is matters ) is being perceived as a start of an early tightening measure than ideally preferred by some in the market. But this perception does not accurately reflect the reality and here is why. So based on the latest (Jan 2014) data, FED’s balance sheet is now around US$ 4.1 trillion and even with tapering the balance sheet will continue to expand and also by committing to keep the rates near zero the FED continues to be in expansive mode. So by reducing the QE level ,the FED is basically trying to slowly dial down the booster engine put in place during the crisis to support the economy and switch over to traditional and conventional monetary policy tools to manage the economy going forward. And the reality is, it will be unwise to expect the FED to keep operating in crisis emergency mode so a gradual switching over makes good sense. Also it is important to note that if the FED gets its QE exit wrong then it could have substantial losses so it will have to be mindful of the market condition. A continued improvement in the economy along with the housing market will enable the central bank to book a substantial profit on the purchased securities and obviously a big chunk of the overall profit will end up at the US treasury and could very well be used to pay down the debt.

Whatever may be the perception of the market today, there is very little evidence to suggest that Quantitative Easing has in fact financed the global growth however, it has been extremely useful in supporting the financial markets and to a large extent helped create a distortion in the asset pricing across the world so a curb in QE will most likely help the global economy remove all the speculations and fear around the nature of the overall growth going forward because quite clearly the markets today aren’t sure if the world economy has entered a self sustaining growth cycle hence the extreme volatility.

And when looking at the bigger picture, in the medium to long term investment perspective, the Emerging Markets ( with the exception of some ) will most likely grow at a better rate than their counterparts in the developed world. Having said that, today when the markets are dealing with extreme volatility that is clearly creating CHAOS then talking about medium to long term investment horizon may not make much sense to most in the market. Also, a wait and watch approach and hoping that markets will look at the big picture and by applying some common sense figure things out is an extremely risky strategy because the markets are all about perception, momentum and confidence so an announcement on a global policy coordination by major central banks from around the world going forward should go a long way in providing a degree of certainty and should help arrest the current CHOAS from spreading into every corner of the market. And the thing about perception is, if you could keep a perception going for a period time irrespective of it being right or wrong then there is a good chance that perception will most likely be perceived by some as the REALITY.

And this is why the global economy of today requires a greater degree of policy coordination from major economies and is essential to addressing both immediate and long term challenges facing the world economy. Also this has to be by far the biggest lesson learnt from the 07/08 financial crisis.


Make a Comment

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

One Response to “PERCEPTION and the Need For Greater Global Policy Coordination in a 2014 WORLD”

RSS Feed for Sonykumar's Blog Comments RSS Feed

Very informative article. I have my doubts about emerging markets out doing the developed markets. Good point about factoring in QE. And BTW how would all the drug money factor into the world economy? Does it affect the EMs, in your amazingly intelligent opinion? Also, do you think it’s fair to use social media to create chaos about a stock?

Where's The Comment Form?

Liked it here?
Why not try sites on the blogroll...

%d bloggers like this: