Emerging markets: the next bubble?

Emerging markets in blue (Image via Wikipedia)

The dot-com bubble went pop, then, more recently, the real estate bubble– and the “Mad Money” stock market deflated along with it. Now that we’re growing accustomed to regular  economic upsets, where’s the next market shock going to come from? According to a growing number of voices, it could come from emerging markets– the boom economies and increasingly fat stock markets of countries like Chile, Brazil, India and, of course, China. And it’s China that’s the key to understanding this new bubble scenario. According to John Authers, writing at the Financial Times, China’s economic recovery (which has accounted for most of the planet’s economic growth since the financial meltdown) looks suspiciously like a government-funded stock bubble. China’s loose monetary policy has pumped money into the economy, but Authers worries much of it may have gone into real estate and stocks instead of fomenting real demand. Financial author Robert P. Smith believes “much of (China’s) stimulus may be going to politically connected loss-making enterprises and thus will result in no lasting growth.” How does that affect emerging markets generally and, possibly, the U.S. economy? Well, the recent huge gains in emerging market stocks hinge on the belief that China, and its commodity-hungry economy, will help pull everyone else out of the economic hole. Some of it also depends on a belief that developing economies in Latin America and Asia have matured enough so that they don’t depend on exports to the U.S., Japan, and Europe to grow. So, even if times are lean in the world’s traditional industrial economies, domestic demand can sustain emerging markets. This thinking is known as “decoupling.” As Jennifer Hughes wrote Aug. 3 in the Financial Times:

Strategists said the rally was because of a returning belief in “decoupling” – the theory by which emerging markets will in future be less dependent on the fortunes of developed markets because they will be able to rely on stronger domestic demand.

Financial Times

The fear, then, is that the stronger demand in China is an illusion, a confection of a stimulus that’s essentially only serving to inflate stock values. Authers even includes a chart comparing the Shanghai stock market’s movements 2005 to date, with those of the Nasdaq between 1998 to 2001. The match is perfect, and might even indicate the Shanghai bubble already has burst, and the rest of the world just has to wake up and take notice. Because China’s a principal trading partner of other emerging market powerhouses like Brazil, India, Vietnam, Indonesia, and Russia, the popping of a Chinese bubble would quickly ricochet around the world. And because emerging markets have become magnets, especially in the wake of the recession in the United States and Europe, for global investment (from Wall Street and elsewhere), the pain would quickly be felt in our economy too. A messy emerging market could batter already-shaky U.S. hedge funds and banks, etc.  Of course, optimists believe China’s recovery is solid.