Equity markets in the US, Japan, and Europe have rallied significantly and have outperformed emerging markets for the year. However, this will be a one year anomaly as borrowing and printing money does not drive prosperity. While Western countries have used the slow economy as a chance to rationalize excessive government borrowing and spending, emerging economies have been able to maintain stability in their governments’ balance sheets. Debt to GDP ratios have climbed in the US, Japan, the UK and the Eurozone rapidly since 2000.
Italy and Greece, which already had debt levels above 100% back in 2000, show the long term consequences of excessive government spending. Their economies are two of the world’s slowest growing economies in the 21st century. The rest of the heavily indebted countries could face the same struggle. They will have to choose whether to cause a recession through a “fiscal cliff” style austerity or continue deficit spending until a debt crisis or high inflation erodes the real purchasing power of the country’s citizens. Both outcomes are severe anchors to future real GDP growth.
Emerging economies on the other hand have kept debt in check. If a Chinese hard landing slows down the region, Asian economies have the cash reserves to stimulate the economy. In addition, emerging central banks can allow domestic currencies to appreciate and stimulate consumption through increased real purchasing power. A rising currency may cost these countries exports in the short term, but those will decline already due to the struggles in Western economies.
With Debt to GDP ratios in emerging markets countries lower due to the higher growth in the region verses developed nations, emerging market debt provides a less volatile option to investors. We have seen equity like returns from this asset class within the past year and it should continue to offer great returns and diversification to investors worldwide.
Written by Sam A.