Evercore Pan Asset

The IMF’s Annual Report links the problems of excessive state borrowing and weak balance of payments. The world’s bank manager calls on countries “that ran excessively high external deficits before the crisis to put in place plans to consolidate their public finances to maintain investor confidence.” They claim that “a key task ahead is to reduce sovereign vulnerabilities, which could threaten financial stability and extend the crisis, as public debt levels have increased significantly”.

The IMF is rightly worried about the continuing gap between east and west, between strong export led economies and the high borrowing import dependent economies. The authors of the Report look forward to a world where the big differences between China and the USA, Germany and Greece, India and Ireland are corrected by action on all sides. They urge the debt ridden countries to cut their public sector deficits first, whilst continuing with easy money.
 
They hope the large surplus countries will expand their domestic consumption and demand, and allow their currencies to appreciate against the deficit countries. By this means the world will come into balance. In an ideal world China will import more from the USA and the yuan will rise making it easier for the USA to export. Greece will succeed in cutting her deficit and will export more to Germany. India will spend more and Ireland will save more.
 
The truth may be somewhat different from this optimistic statement of intent. The IMF has power to influence the economic policies of the countries that borrow from it. Poland, Mexico, Iraq and Romania were amongst those borrowing from the IMF last year. The IMF is not currently lending new money to the key players, China, the USA, Japan, India, Germany, France and the UK. It has little or no power to influence them. As the IMF acknowledges, the danger in the current situation is continued large money flows into the stronger emerging market economies. This will drive asset values ever higher, for shares, property and other assets in these countries. As China and others amass ever larger surpluses, so they will recycle the money, lending a lot of it back to western governments. 
 
The IMF forecasts 4.8% growth worldwide this year followed by 4.2% next year. The emerging market economies will be growing at more than 7% and the advanced countries at around 2.7%. The recovery will be slower in the west than normal for this stage of the cycle. They expect the Asian surplus to get larger and larger as the years pass.
 
Meanwhile the western authorities are considering whether to institute a second round of quantitative easing (QE2). The US President is clearly happy for the Fed to be talking about QE2 ahead of the mid term elections, as it encourages a more bullish market and better sentiment. The UK has one voice on its Monetary Policy Committee in favour, with some others worried about the persistence of relatively high inflation already speaking against. It means both the Fed and the Bank of England are reluctant to tighten or raise interest rates any time soon. 
 
These conditions have been benign for asset values. The rush to invest in the emerging markets has fuelled good rises in their asset values, as western investors seek to catch up with the new economic reality. Discussion of even easier money in the west has allowed some more recovery in western share and bond prices. The refusal of all the main currency areas to revalue their currencies has led to a fight to the bottom. In the short term the Euro has been losing this fight, rising in value against the dollar and sterling.
 
The wrong currency is rising as a result. We fear there will be another phase to the Euro and European sovereign debt crisis, so we recommend avoiding European shares. The rise in the Euro is the last thing Ireland, Spain, Italy,  Portugal and Greece need. China is not keen to allow the yuan to rise, so we have to live with the continuing large world imbalances. The IMF has made some sensible comments,  but it does not have the power or the will to resolve the tensions.