Bernanke throws the dice as funds look on bemused

Chairman of the Federal Reserve, Ben Bernanke’s speech at the International Monetary Conference this week reveals the delicate balance between the (stagnant) state of the US economy and the enormous growth of the emerging market economies.

Of course in absolute terms the US is still leaps and bounds ahead of its country in waiting, China, but it’s both the speed of the growth of the emerging countries – which is not restricted to China – as well as the relationship their growth has with the US economy, that is interesting.

The opening remarks in Bernanke’s speech were that US economic growth so far this year “looks to have been somewhat slower than expected”.

The ability and willingness of households to spend, he says, will be an important determinant of the pace at which the economy expands in coming quarters. So far they haven’t been obliging, and one of the key determinants holding back consumer confidence, and so consumer spending, has been the rise in commodity prices.

And why have commodity prices been rising? Well, supply has been waning, but importantly on the other side of the equation it’s due to the enormous growth in demand, being driven by the emerging economies.

According to Bernanke, there has been a dramatic shift in the sources of demand for commodities including oil, and even more dramatically in industrial metals where in the past 10 years, double-digit percentage rates of decline in consumption by the advanced economies have been overwhelmed by triple-digit percentage increases in consumption by the emerging market economies.

Of course the price of commodities is not just a consumer spending issue but also an inflation-management consideration for the US.

At the same time that the US’s growth is “lower than expected” the growth of the BRIC countries has been faster than expected. In 2010 China overtook Japan as the world’s second largest economy, and Brazil reached the top five, six years ahead of the then prediction by its President in 2009.

The pace of growth has also surprised the man who coined the BRIC term, chairman of Goldman Sachs Asset Management, Jim O’Neill.

“Back in 2001 when I first coined the term, in the original paper introducing the importance of the BRIC economies, even the most optimistic of the alternative scenarios I looked at suggested that China might become as big as Germany, but no larger than that. Brazil didn’t seem as though it would be anywhere near the G7 economies this soon,” he said in a recent paper.

From the institutional investors’ point of view, emerging markets are somewhat of a darling.

Long-term investors around the world are increasing their exposures to emerging markets, the Government of Singapore Investment Corporation the latest to emphasise its commitment to emerging markets, appointing three top executives to new positions.

At the same time US pension funds are leading the trend to reducing domestic equity allocations, and increasing international exposures, including emerging markets.

While Bernanke emphasises the role of the consumer, in this speech at least he doesn’t address the role that pension funds, and other large pools of money, which also have a long-term time frame, can play, and have played in the market.

(Some state politicians are clearly thinking of this within their own backyard: see the interview, In Conversation)

From the US’ point of view the good news is that Bernanke recognises, and urges the recognition, that the nation’s fiscal problems are inherently long-term in nature. And that the appropriate response is to move quickly to enact a credible long-term plan for fiscal consolidation.

But perhaps what is less clear is the role that these large pools of capital can play in shaping the new world order.

The dice have been thrown up in the air, and the economies of the world are landing in an order even those most predictive of minds can’t forecast. It seems the new world order is a long way from settling.


Editor’s note: I withheld referring to “The Ben Bernanke” and “The Goldman Sachs” in this column, but with the QE2 program due to come to an end at June 30, it’s worth re-watching the YouTube video that made the monikers famous