Investing In A World Of Global Economic Imbalances

Coverage of the 2010 Global Investment Conference

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emerging-currencyEmerging economies will overtake developed economies within five years and developed countries will face huge consequences as a result unless governments make some tough choices, research from CIBC Global Asset Management indicates.

The breathtaking growth observed in the emerging world over the last decade should have been accompanied by the appreciation of emerging currencies against developed ones. However, heavy intervention by central bankers in the emerging world have kept emerging currencies undervalued, resulting in widening global economic imbalances between emerging countries and developed countries. Emerging economies are benefiting from current account surpluses and sound fiscal positions while developed economies are saddled with current account deficits and deteriorating fiscal balances. The only way to bring the global economy back into balance is for emerging countries to allow their currencies to rise against their developed country counterparts. Unfortunately, monetary authorities in the emerging world seem to be in no hurry to let their currencies appreciate.

CIBCGAM-ChartIn this context, the developed world is facing increasing pressure. Over the years, economic imbalances have led to a sharp deterioration on the fiscal front in the developed world. The situation recently took a turn for the worst when governments in the developed world deployed fiscal efforts of unprecedented proportions to cushion the 2008-2009 economic downturn. In the emerging world, fiscal deficits during this downturn were lower than in the developed world. In the next decade, debt to GDP ratios should average 106% in the developed world but only 36% in the emerging world. (Download a PDF of this chart)

Time is running out for governments in the developed world. They have less than ten years to restore their fiscal balances before fiscal deficits shift definitively on an explosive path due to an ageing population. To avoid such an outcome, governments in developed countries will have no choice but to make large fiscal adjustments over the coming years while their economies are still growing.

This fiscal austerity will significantly depress economic activity in the developed world over the next decade.  Governments will have to cut spending and increase revenues by a combined 6% of GDP between 2010 and 2020, a fiscal adjustment of around 0.6% per year. This amount doesn’t sound like very much, but it is significant because we expect economic growth to slow markedly in the developed world even without fiscal austerity. Tightening efforts on the fiscal front will act as an additional source of drag on growth.

A lower growth environment points to lower returns from all assetLepine classes to various degrees. Based on our forecast, the future won’t look like the past. Using a traditional asset mix, instead of getting the 10% annual returns observed over the last two decades, pension funds are likely to get around 5%.

Pension funds will have to work a lot harder to get the growth in assets they expect. Here are some issues to consider:

– Relative growth differentials will shape the global financial landscape, impacting all asset classes from money markets, bonds, equities to real estate, resulting in a more meaningful role for tactical asset allocation.

– Global economies will rebalance when emerging market currencies rise against developed market currencies. These currency developments need to be considered when making long-term asset allocations.

– Pension funds have to start working with different risk metrics.  Emerging markets are risky, but one could argue that the developed world is getting even riskier.

– Last but not least, regional allocations will make a huge difference in performance.

Vincent Lépine is vice-president, Global Asset Allocation and Currency Management with CIBC Global Asset Management inc.

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