ray dalio recently compared the situations of creditor emerging nations to that of debtor developed ones. the emerging world is overheating, with rising inflation and asset bubbles, while the developed world is mired in sluggish growth, high unemployment and low but rising inflation.

this comparison made me think that the world looks a bit like the eurozone did some years back, writ large. when the german and other euro-"core" economies were sluggish, the ecb ran its one-size-fits-all monetary policy to stimulate the core. this overstimulated the periphery, notably the piigs, and set them up for a later crash.

countries, like china, which peg their currencies to the dollar essentially have to follow the monetary policies of the u.s. fed, so in a similar way a loose policy for the sluggish developed world core is being applied to the periphery-developing countries, leading to overheating in china et al.

the most frequently identified asset bubble in the emerging world is in chinese real estate, characterized by overbuilding and ever-rising prices.

so Asian real estate is looking a bit like spanish and irish real estate a few years back- bubbling up in price. HOWEVER, the proficiency of the periphery-developing countries as exporters is in sharp distinction to what happened in europe. there, the peripheral countries are IMPORTERS from the core countries, especially from germany. globally, however, it is the core, the developed world - the u.s. especially- which are importers.

mounting trade surpluses exerts pressure on em currencies. in order to prevent their currencies from rising, the em central banks intervene. but this creates more inflationary pressures for them. the pboc has been trying lately to apply countervailing pressures internally with increased reserve requirements and administrative controls on the real estate market. but the pressures continue to mount toward higher interest rates and higher exchange rates.

the ecb runs monetary policy essentially around the needs of the core [this could be because the core is by far the biggest part of the eurozone economy, and/or because the ecb has felt it must live up to the mantle of its predecessor, the bundesbank. under the pressure of global sluggishness, this latter effect appears to be diminishing over time.] so lately, as the german economy is heating up, the ecb has recently raised rates. austerity in the euro-periphery, however, will hurt german exports within the eurozone, just as a strong euro will hurt german exports to the rest of the world, so i doubt we will see much follow-through from the ecb.

the fed, too, runs its policy around the needs of the "core," the u.s., but in this instance it must continue to lean toward ease.

although em's have complained that u.s. money printing has exported inflation to the world, it would be easy enough for them to counter this effect by letting their currencies rise. however, to do so means giving up some of their ability to export, something they are loath to do. in the u.s., the end of quantitative easing ii and the wearing off of prior years' fiscal stimulus, combined with a rising political urge for austerity, will produce a further slowing in the global core. this would relieve inflationary pressure for the em's, but also reduce their ability to export by crimping core demand.

this diminution of exports may be sufficient to prick the asset - especially real estate- bubble in china. in such an event, i would expect the chinese to stimulate with further public works, more train lines, more road building and so on, just as they did 2-3 years ago. but although this would ameliorate a chinese crash in the short run, it is not an intermediate-term solution. that would only come from another round of easing in the core, re-establishing demand for chinese exports, or from the cultivation of chinese domestic demand.

i expect a u.s. slowdown to take down commodity prices. but if a slowdown in the core does indeed crash the periphery, expect a MAJOR selloff in commodities, with the possible exception of gold, which is likely to selloff too, but more modestly.

an alternative scenario would be for the chinese to sharply revalue their currency upward at the same time that they effect domestic stimulus. [this was dalio's prediction.] since exports would already be constrained by the weakness of the core, there is less to lose by having a stronger yuan. the revaluation, however, would immediately reduce inflation by lowering their domestic currency price for imported oil, food and raw materials. and the purchasing power of yuan-based incomes would rise to offset, at least partially, the effects of chinese economic slowdown. increasing domestic purchasing power would also be a step toward cultivating domestic consumption markets.

in this latter scenario, commodities might not selloff quite as much, since chinese demand would be more resilient. [i.e. oil and food would go down in dollar price in the core, but go down a lot more for chinese purchasers spending their newly strengthened yuan.]

i have focused on the chinese case, as it is the most important of the creditor-exporting-developing nations. the same analysis applies to a somewhat lesser degree to the other developing/periphery countries. resource exporters like russia, chile, peru and brazil, for example, are likely to be hurt more by a fall in commodity prices.