Back to the Future

by Jayant Pai | jayant@ppfas.com

“Nothing is permanent in life”. This adage was reinforced when I  read an article by Ruchir Sharma (of Morgan Stanley) just now, prognosticating the rise of the US Dollar (USD) over the next decade. Apparently the past decade’s fall in the USD’s value was due to the tepid stockmarket in the USA and a correction of the strength experienced by the USD in the nineties. The strong currency led to yawning current account deficits (As a percentage of GDP) and consequently falling competitiveness as exports were priced out in many industries.

The turn of the century also coincided with the rise of the large emerging markets as US consumer imports from China and other countries ballooned on the back of a strong currency and it became economical for exporters of capital to invest in the emerging markets. This led to linear extrapolations in 2009-10 predicting the permanent rise of emerging markets and the permanent demise of the USD.

Now the tide seems to be turning, partly on the back of risk aversion and partly due to the US economy’s improving fundamentals. Current account deficits have reduced sharply from around 7% in 2007-08 to 3% as of date.

The sustained fall in the USD for the past few years (coupled with the slack labour market and low interest rates) have led to potentially rising US competitiveness with several large firms contemplating shifting part of their production back to the USA.

Also, the problem of plenty faced by China, Brazil and India in the form of inflation, rising wage rates, currency appreciation over the past decade (India excepted) will put a spoke in the wheel of the emerging market fairytale.

In case the prediction actually pans out as per the script we could see the following effects :

  1. US stockmarkets will outperform as more investors go overweight on US markets.
  2. Currently, the US consumer is undergoing a deleveraging phase but this should play itself out towards the middle of this decade. We could then see rising consumer activity. Productivity of US labour was never in question. Rising investments may also lead to a rise in actual numbers employed.
  3. The wealth effect could rear its head again as rising stock prices and stable/rising house prices provide an impetus to consumption, although the degree of leverage will be more muted as the ghosts of the past will not be exorcised so easily.
  4. Emerging markets will feel the pangs that a ditched lover feels, as investors no longer flock to them. However, this could be a blessing in disguise as hot money flows too will subside.
  5. Weak currencies over a period of time, will spur export oriented industries in emerging markets. Hopefully, the past few years of prosperity would have also helped them invest in infrastructure which would help them move up the value chain with regard to exports.
  6. While emerging stockmarkets may not be as frothy as they were in the past decade, a whole new set of stocks and sectors could lead any impending rally. While, predicting these is easier said than done, we may safely say that commodity producers would not assume leadership.
  7. Prices of oil and gold which are ostensibly negatively linked to the USD could also reverse course, thereby providing respite to consumers of these products.
  8. Net-net, we may witness the mirror image of the ‘Noughties’ (2000s) although it may be more US-centric rather than developed world centric, given Europe’s travails.

In such a case, it may make sense for Indian investors to spruce up their knowledge of US listed entities and invest there either directly or through investment vehicles such as international funds or Exchange Traded Funds (ETFs) dedicated to the USA. Alternatively, stash your Resident Foreign Currency (RFC) Account with as many dollars as the Reserve Bank of India would permit.

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