Lessons for the Emerging Economies from the U.S. Experience

In the 19th century, the U.S.A was considered to be an emerging economy.  Its growth was driven largely by the cotton industry and development of infrastructure such as canals and railways. The importance of cotton industry to an economy can be compared to today's crude oil, manufacturing of automobiles, semiconductor, cellular phone devicves.. etc.

The U.S. was responsible for about 5/6 of cotton supply in the world, and the economy prospered as the price of cotton stayed relatively high. However, from 1837, the price of cotton began to plummet, which caused a huge dent on average disposable incomes in many states. What this means in today's world is that if supply and demand equilibrium of certain products or industries takes a turn for the worse, the countries that rely on exporting of such goods will be affected negatively.

In addition, the U.S. experienced a huge boom in canal construction. A constructuion of a canal around Lake Erie (New York, Detroit and Cleveland) led to a much more efficient transportaiton of raw materials and finished goods between cities. Inspired by their successes, more canal projects were undertaken by capitals from Europe (mostly England). Equities of many canal related stocks delivered huge gains to investors. Combined wtih a huge boom in the cotton industry as well as capital infusion from the European investors, the U.S. real estate prices rose rapidly.

As more English investors put their money in the U.S. market, the capital became more scarce in England. Its gold reserve was halved and in response to this, the English central bank raised its benchmark rates. All of a sudden, the constant inflow of capital from Europe (England) to the U.S. stopped and the U.S. asset markets took a huge beating. Many cotton producers, banks and real estate investors were out of busienss, and the losses by foreign investors spilled over to their countries. Although the U.S. economy is the largest one now, the way of getting there was not all roses. Rather it experienced many cycles of booms and busts.

Back to the present, in the last few years, the Federal reserve and ECB have lowered their bench mark rates significantly as their concerted efforts to shore up the economy. Although many emerging nations followed the suit, their yields are much more attractive compared to the U.S. Treasuries. More importantly, they are considered to have more sound fiscal situations and currencies that "hot monies" are slowly flowing into these countries, putting upward pressure on their currencies. However, some emerging countries are concerned about fickle foreign investors (indirect) that can cause chaos in their financial markets if too many of them try to liquidate and repatriate their investments back to their home countries. That is why some Asian countries such as China, S.Korea and Taiwan have implemented or seriously considering measures to slowdown infusion of foreign capital.

Btw, happy holidays to everyone!

(Credit: Tomorrow's Gold by Marc Faber)