2011 was much worse for investors’ nerves than it was for many financial markets. Major U.S. stock indices, for example, ended the year pretty much where they began, but the path to get back where we started felt more like a roller coaster than a stroll down a nice flat road. In most cases, you got off where you got on, but there were a lot of steep ascents and gut-wrenching declines in between. For assets that appeared to be riskier, such as emerging market equities, the roller coaster actually let you off at a significantly lower place than where you first strapped yourself in.
We all know what was behind the volatility: the protracted European debt crisis, the acrimonious and unproductive debate about the U.S. government’s finances, and the fears of a hard landing for important emerging economies. I’ve written plenty about the first issue and for the second, I’ll follow the maxim that advises that if you have nothing good to say, keep quiet. But for the third, I’ve started seeing some encouraging signs. The markets have noticed those signs as well.
A year or so ago, we worried that the aggressive stimulative measures that governments and central banks in the emerging world took to offset the financial mess in the U.S. would lead to overheating and a return to the kind of inflation that’s plagued many of those countries over the years. The attached chart shows that we had reason for concern in late 2010 and early 2011. But something new, at least in many places, occurred. Before inflation went truly vertical, countries began to reverse their easy money policies and put on the monetary brakes. And what do we now see? Those inflationary pressures have begun to abate.
Of course, recent experience has led us to expect a turn for the worse to follow any good news, so we began worrying that tightening policy would lead to a series of hard landings, dashing our hopes for finding one bright spot in an economically volatile world. But countries from Indonesia to Peru (traveling west, that is) have begun to ease policy and allow a sustainable level of growth to continue.
Will they all get it right? No. Some will bow to political pressure and risk inflation by easing too much—and too soon—rather than see growth slow. I worry particularly about India in this regard. Nevertheless, the pattern of easing when the economy slows too much, and tightening when it threatens to boil over, seems to have become the policy strategy across a range of rapidly growing economies. We’ll have to watch, but if I’m correct about this trend, the world has a powerful engine of economic growth that can replace the roller coaster with a much less jarring ride.