It’s a big world out there. And it may not be as flat as we thought.
The current recession is the deepest in many decades and has affected all areas of the globe. But policy responses have varied greatly and many economies are seeing different results.
The president and CEO of the Federal Reserve Bank of San Francisco, Janet L. Yellen, said in a speech this week, “For economic policymakers, this crisis has been like a hundred-year flood — a disaster of the highest order which has put us on a continuous emergency footing.”
The response of the U.S. Fed has been equally unprecedented. The Fed has a near-zero federal funds rate that has done little to turn the economy around. The Fed is now also a major buyer of mortgage-backed securities and longer-term U.S. Treasury debt. This helps keep bond rates at what are still historic lows.
Dr. Yellen argues these actions are desperately needed to encourage consumer and business demand and that inflation will not be unreasonable. She said, “I take 2 percent as a reasonable benchmark for the rate of inflation that is most compatible with the Fed’s dual mandate of price stability and maximum employment.”
That’s where we differ from that big world out there.
Central banks in other countries do not have a “dual mandate.” Price stability is the sole goal of most monetary policy institutions around the world.
The European Central Bank is responsible for maintaining the euro's purchasing power and thus price stability in the 16 European Union countries that have adopted the currency. Similarly, the Bank of Japan is charged with " achieving price stability, thereby contributing to the sound development of the national economy."
It’s been said you cannot serve two masters. The dual goal of the Fed creates volatility and conflict not present in other capital markets.
Since the onset of the crisis last fall, the ECB has been criticized for not easing interest rates as fast as in the United States. The different policy responses have led to different market responses. Since October of 2008 major U.S. stocks are off roughly 26 percent while their European and Japanese counterparts fell only 19 and 17 percent, respectively. Yes, the crisis has it the entire world economy, but the correlation suggested by a proponents of a new globalized, or ‘flat’, economy remains low.
The low correlation between financial markets is advantageous to investors.
Diversification is the reduction of risk achieved by replacing a single risk with a large number of smaller, unrelated risks. Diversifying investments across many stocks, primarily through mutual funds, is how most investors act.
Most U.S. investors, however, do not take advantage of international diversification. Here in the U.S. we tend to overweight the U.S. market in our portfolios.
Emerging markets such as Brazil and India are moving out of the current crisis faster than the U.S. The Brazil stock market has returned to its price level of last October, and the Indian market is 25 percent higher.
U.S. companies have seen these opportunities and are acting on them. McDonald's announced this week plans for further expansion in India. Tyson Foods Inc. purchased three Brazilian poultry firms over the past year.
The world may be more interconnected, and thus flatter, than previously, but the recession will hit harder in some places than others. Policy responses will differ dramatically, and economic activity will respond with equally different magnitude.
Investors and business managers alike can gain by looking around globe.
Since 2000, Peter R. Crabb has been a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.