3. The China Factor
In the 2004 to 2008 commodities bull market, Fed Chairman Alan Greenspan’s easy monetary policy generated a U.S.-led global bull market in stocks and commodities. Growing U.S. consumption — in tandem with the housing boom — spearheaded the global surge higher, driving outsourcing manufacturing to China.
However, despite rising commodity prices, China’s cheap labor cost managed to offset much of the inflationary pressure created by declining U.S. dollar and high commodity prices. Back then, China managed to export deflation to offset higher commodity prices and keep U.S. prices in check. Also, much of the excess capital went into the U.S. housing sector.
After the global financial crisis, China and other Asian countries pumped massive liquidity into their economies, allowing these countries to recover much faster than the United States and Europe. Although Bernanke tries to reflate the U.S. economy, changes in the U.S. financial services industry made it more difficult to do so now than in the Greenspan era. With the creation of massive liquidity, China has experienced higher inflation as well, the impact of which is largely offset with wage hikes. Labor cost in Chinese coastal cities surged more than 40% in U.S. dollar terms during the past two years.
Companies involved in Chinese domestic consumption, such as Ctrip.com International (NASDAQ: CTRP), Louis Vuitton Moet Hennessey (OTC: LVMUY), NetEase.com (NASDAQ: NTES) and Starbucks (NASDAQ: SBUX) welcome these wage hikes as consumers will have more money to buy their goods and services.
Even though the U.S. financial services industry is less efficient now in pumping liquidity into our economy, the Fed will still eventually have its way. But this time around, China is actually exporting inflation instead of deflation. With the combination of the Fed endlessly pumping cheap dollars, higher raw material prices and higher costs in China, inflation is starting to surge in America as well.
So even as inflation starts to come under control in China, things are just beginning to pick up here. During times of inflation, the textbook investment strategy is to increase debt, invest, and then repay the debt with devalued money.
Overall in 2011, I am expecting a strong year for global stocks, commodities and even real estate — especially in international cities. However, I recommend staying away from U.S. Treasuries and to beware the shrinking dollar.