Perhaps rather it was a natural consequence of the modern portfolio theory taught in the United States, to diversify and take higher risks, coming on the back of what wsa then a ten-year-old bull market. From the developing countries' position, private investors were offering capital at no annual interest rate (we called it equity; they called it free, without management strings), which was more attractive than bank or government lending. It was a meeting of lovers and there was a love fest. And now, they have matured with all of the obligations and responsibility that come from the next age level. Mobius selects the largest countries as the ones with best future potential presumably for the attractiveness of their domestic markets. The first rush of emerging markets was for export sales and that is now over. He is right to emphasize places like Nigeria and Egypt. And he is right in the sense that if he is wrong, these overpopulated countries will not tolerate a world with such huge disparities of communications and living standards.
But before we get to 2010, we must deal with the traumas of the late 1990s. Since the beginning of the Asian crisis in July 1997, there has been an approximately 50% decline in emerging markets. It started in Asia, became most visible and most illustrative in Russia, with about a 90% decline, approximately the same as in Indonesia, the fourth largest country in the world in terms of population. And pressure built up in Latin America.
rates, in higher markets, to take them out. And even if not at higher levels, they take them out anyway because emerging markets on the whole look like a considerably less attractive place to invest than they did five years ago. This is a world-wide phenomenon, not just limited to Indonesia, Russia and Latin America.
What is it all about? The mixture of rising nationalism and deflation is very potent negative medicine for emerging markets. Reform of banking systems means banks have to recognize bad loans. Interconnectivity means that when something happens in one part of the world, the rest of us all feel it. This is not necessarily a dramatic buying opportunity except for those people who can watch the hourly news. And yet, we are setting up the conditions by which the long struggle of the workout period can take place. It is probably some distance into the future, but the early dramatic decline has certainly been felt.
In the meantime, there will be continual turmoil in these countries, promoting more nationalism, more separation from the international community and yet more necessity on the part of the developed nations, especially the United States, to support them.
China may be different in the sense that it has a high surplus of dollars with its very positive trade balance with the United States, and it may come out of this phase as the dominant emerging market. Mobius is right about the necessity for structural reform but this country seems destined to dominate its region and possibly to be the next sole superpower. It is a tremendously powerful force in the region and in the world, and the group that is running China now and in the next decade is very competent. We should pay careful attention to them.
Meanwhile, the United States itself looks increasingly like an emerging market. As with most emerging markets, it depends entirely on an inflow from outside its own borders in order to survive. There is a negative savings rate, and debt cannot be liquidated on its own but only rolled over, a characteristic of an emerging market. And it is very much an overbought emerging market having extended a very great boom for essentially the last 18 years. But more than that, the United States is an emerging market that has turned over its financial responsibility to the rest of the world. The degree to which the country borrows in dollars is helpful. But the degree to which dollars are held by foreigners is harmful since foreigners can start liquidating those dollars in order to meet their own demands. As an emerging market, it is not clear that the United States would meet the IMF requirements for borrowing, a strange concept given the extent to which it is perceived to be the safest
Think of a swamp fire, or a fire in a coal mine, where underneath the ground there is a common smoldering heat source, which every once in a while flares up to the surface where it must be put out. Firemen come in and douse it with water and fire extinguishers and that flame goes away. Six months later, it comes up again.
This is what the conditions are today in emerging markets. In Indonesia, South Korea, Thailand, Malaysia, Brazil, Russia, Mexico one after another we get a flare-up. But it is all the same thing. It is a preference for risk-averse investing. It is a preference for guaranteed returns. And it is an aversion to the downside risk of a free market that extracts a penalty for over-exuberance. We have to treat the basic fire, rather than just the flare-ups.
Each emerging market considers itself unique in attempting to solve its own problems. But the problems are quite common. In order to rebuild their economies, most emerging markets have borrowed heavily in dollars in this capital-plentiful period. Investors have also invested dollars in those economies and now plan, at higher
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