Interest rates spiking in strong growth countries

Interest rate increases are beginning in strong growth countries. India raised interest rates in a surprise move on Friday, March 19, 2010. This followed recent interest rate increases by Australia and Malaysia, all three countries are experiencing strong economic growth and rising fears of inflation.

There are of course consequences of rate increases, especially as they spread to more countries, some time in the future rising interest rates will lead to the moderation of the strong economic growth that Asia is currently experiencing.

In our opinion, this will not happen until Asia has dragged the world out of much of its current malaise.

China is today’s engine of world economic growth. The Euro zone is in terrible shape ten years after it was launched with high expectations of solving Europe’s problems with over-regulated markets, over weaning welfare states in some countries, and with expectations for increased trade within the bloc. After ten years, trade has improved, but the other problems still exist.

The welfare states suck the lifeblood out of the community, and much like our state of California, where many public servants retire after 25 years of service and receive very high pensions, Greece, Portugal, and several other Euro zone countries are in deep financial trouble. The members of the Euro community must choose either the status quo, which will mean the type of economic stagnation we have predicted in these pages for some time, or the alternative; to cut benefits and require public employees to work to a more reasonable retirement age.

With Japan stagnating for over twenty years, the Euro zone facing a long stagnation, and the U.S. suffering from an irresponsible spending regime, China is the world’s economic engine presently.

China supports the growth of countries such as Brazil, Australia, Canada, Indonesia, Malaysia, the U.S., and others by purchasing their raw materials and foodstuffs. They support machinery manufacturing worldwide by purchasing machines, machine tools, and other implements to build out the Chinese infrastructure and manufacturing base.

Today, we should all be aware that the world economic crisis would have been much more serious without the benefit of Chinese demand. Other countries, including India, have also played a part in this shift of economic demand from the West to Asia.

It does not appear that the U.S. and Europe have the flexibility to increase interest rates. Their economies are too weak and their underlying financial condition too debilitated to take the action of heading inflation off before it arises, which is what several countries in Asia and the Pacific Rim are trying to accomplish.

The U.S. is employing an inflationary monetary policy, and there is no doubt in our minds that the U.S. will eventually suffer from another bout of inflation such as we saw in the 1970’s. On the other hand, Europe led by a frightened Germany is heading toward slow growth and a more deflationary future. Why do we say that? Germany does not want the German taxpayers to bail out Greece, and perhaps several other European nations with financial problems [such as Spain, Portugal, and Italy]. They would rather have the IMF do the dirty work of forcing the over-extended countries to reform. The entrance of the IMF will help German taxpayer who would otherwise have to pay the bill for the profligate spending of others. The IMF always prescribes deflationary cost cutting and tax increases in cases such as Greece’s. Tax increases and spending cuts will impede Greece’s and possibly several other European countries’ growth for some time.

The global equity markets’ response to Greece’s problems…has been to rally. The Greek fiscal crisis has accomplished two things to help support equity markets. 1) It has convinced equity buyers that monetary policy in the developed world will remain loose for an extended period of time, and 2) it has given investors another reason to shift asset allocations away from some countries’ government bonds into an asset class that offers the opportunity to grow; global equities.

Consider the costs of the wars in Iraq and Afghanistan. At the beginning of the Iraq war we stated in no uncertain terms that the economic consequences of the war would be to burden future generations of U.S. taxpayers with declines in their standard of living due to the debts incurred by the current generation’s leaders. When the Afghanistan war began, we repeated the warning.

Today, we believe that, the U.S. unfunded liabilities for Medicare, Social Security, and health and retirement for service members and other federal employees as well as other “entitlement” programs total about $38 trillion. Remember, this liability is unfunded.

The current U.S. healthcare bill may be even more expensive than the wars. Now it is our unfortunate duty to point out that the current healthcare bill will further burden and encumber the coming generations of American taxpayers. There is no question that U.S. companies will re-evaluate the costs of hiring new employees, and that corporate profits, and thus stock market prices, will be heavily impacted by the cost burden that corporations will be faced with to support the uninsured.

Just as with the cost estimates associated with the wars, the actual costs will likely be trillions of dollars more than the politicians report to the taxpayers; costs are conveniently forgotten, or worse, just lied about through lowball cost estimates by the Congressional Budget Office.

The healthcare bill will be very expensive for future generations. The big question is, how long will it be before the world realizes that, like Greece and many other nations, we are living beyond our means in the U.S.?

Currently, the U.S. and many Asian markets are rallying. Longer term, the costs will hurt U.S. corporate profits and stock prices as well as cause a rise in capital gains taxes, but the market has decided to focus on the positives that have developed in the short term.
There is plenty of cash available for stocks because investors are afraid to buy bonds. They fear bonds because many investors see inflation on the horizon in 2011, and they do not want to own bonds when interest rates are rising. Hence, they are selling bonds to purchase stocks. Additionally, the uncertainty surrounding the healthcare bill is now behind us, and the market sees that that income taxes will not rise until 2011. This confluence of events has caused them to return to enjoying the rally that began in early March.
On the positive side, commercial real estate is being refinanced, and the feared massive foreclosures of commercial real estate will probably not develop. Many U.S. states have problems, but investors are focusing on the problems in Europe and temporarily ignoring the U.S. problems. In essence we believe that investors are saying, “Make hay while the sun shines”.

We suggest that our readers focus their investments on exporting companies, food related companies, raw materials producers, iron ore, oil, coal, technology, and on stocks of other countries, especially those countries who can export to the fast growing nations such as India, China, and other Southeast Asian nations. Even U.S. financial stocks are enjoying a rally as a result of the end of uncertainty. We own some U.S. bank stocks with a short term investment horizon.

We will continue to avoid most Japanese, European, and U.S. stocks that produce products for domestic consumption. Gold is in a trading range, as it approaches the bottom of the range, we will add to gold shares.

Guild Investment Management, Inc., a registered investment advisor. All material presented herein are solely the opinions of Monty Guild and Tony Danaher. Investment recommendations and opinions expressed in these reports may change without prior notice. Read Monty and Tony’s past periodic market and economic commentary articles by going to the Commentary Archive on www.guildinvestment.com.