A recent meeting we had with Michael Spencer PhD, Chief Economist for Deutsche Bank in Asia, outlined a number of extremely useful insights into how Asia views some of the current international issues around Central Bank activity, as well as some of the long-term economic trends at play in the Asian region, and their importance for the New Zealand and Australian economies. We will look more closely at some of the key issues that came out of this discussion.

In the short term, the key policy issue is the management of capital inflows into small, open, emerging market financial systems. Policy independence in an environment of prolonged zero rate policy in the US is a desired result from Central Banks, and they are increasingly looking at capital controls to achieve this. One area of concern is that high capital inflows from the US into emerging markets could lead to emerging market asset bubbles.

Contributors to such an outcome as mentioned above would include: excess global liquidity, a weak US dollar, and an ineffective monetary policy tightening response from Central Banks in emerging markets. A significant value to watch is inflation pressure in emerging Asian economies.

Likewise, we appreciate these risks, although we note that despite large inflows of capital into emerging markets, these are coming off a relatively low base, and many worldwide fund managers still hold only moderate weightings to the emerging world. It is important to note that such a scenario is simply a risk to be aware of, rather than our expectation.

In the current market, there is a conflict between most central banks, who are tightening (raising interest rates), and the Fed, who are loosening (keeping interest rates at very accommodative levels, virtually zero). A lot of the Central Banks disprove of the Fed for essentially trying to devalue their currency, and they are also conscious that periods of crisis in emerging markets have tended to follow periods of loose US monetary policy. As a consequence, this loose Fed policy could lead to increasing inflation, credit growth, and the asset bubbles mentioned earlier.

If problems do arise, it will likely be when the US starts to tighten and raise interest rates. This could have negative implications for markets and growth.

If inflation does increase rapidly, it is of some comfort that the Fed can tell banks to increase reserve requirements from 10% to 15%, as Asian central banks have done in the past, to curb excess credit growth.

From the Fed’s view point, it clearly wants the Chinese currency to appreciate so it can shift some growth away from China and back to the US. Conversely, China sees itself as the less wealthy country and would prefer to keep all of that growth for itself.

Looking from a more international perspective, Michael notes that while global growth has slowed in the third quarter, it is far from a double dip, and he is not expecting one. Michael’s team is forecasting 2011 growth in China of 8.7%, India 8.1% and the rest of Emerging Asia 4.6%. This compares with 3.6% in New Zealand and 3.2% in the US.