Emerging markets provide a lesson for the West

President Bush heads to Asia this week, where he'll be able to see the emerging world at a crossroads, particularly China. Much more rapidly than its Asian predecessors, China has reached the limits of its export-led growth model. It must now shift to finding more efficient ways to use scarce natural resources to produce economic growth and concentrate on developing domestic demand. Perhaps it is China's sheer size, but it simply overwhelmed the West's ability to finance its development, a process that took Japan, South Korea and Southeast Asia several decades to achieve.

This weekend when the Olympics kick off in Beijing, that development - and its excesses - will be on display for Mr Bush and all the world to see. For investors, some are calling for a shift to high-yielding emerging-market stocks, the dividend plays. The logic here is to capitalise on the potential for continued growth in the developing world, while harnessing the yield. Unlike a bond, a high-dividend stock provides a yield with a natural hedge against inflation in the underlying asset, the stock.

Not the first time this compelling advice has emerged even though it has yet to pay, er, dividends. As Keynes once observed, markets can afford to be wrong longer than you can afford to be right. With decouplers in retreat, it seems that emerging markets will be victimised alongside equities in the West until evidence emerges to revive faith in the decoupling theory. Until that happens, buyers of the dividend play may find their yields cold comfort.

In the US, the employment picture continues to darken. Lower oil prices are at least giving the Fed and other central bankers the relief on inflation they have been waiting for - and helping to spark a small recovery by the US dollar. The pressure is therefore off the Federal Open Market Committee to raise rates at today's meeting and possibly worsen the slowdown. The Fed is also getting help from an unexpected aberration of the ongoing slowdown - resilient productivity growth.

Strong productivity growth reduces the impact of inflation, reducing the need for the Fed to raise rates. This is important, because the housing debacle is only spreading, with creditworthy mortgage borrowers now falling behind on payments. That, economists say, is likely to be the death knell for even more banks. In the Gulf, by contrast, low productivity growth must make inflation seem even more acute. Saudi inflation is now running at 10.6 per cent, joining the double-digit club. According to the latest Big Mac index compiled by the Economist magazine, the dirham is undervalued by roughly 24 per cent, meaning its 24 per cent cheaper to buy a Big Mac here than the global average. Supersize me.

We can only hope that governments are heading against the likelihood that oil prices could tumble. Spending by governments in the GCC is projected to rise 25 per cent this year to $300 billion. According to Brad Setser at the Council on Foreign Relation in New York, that works out to roughly half of the Gulf's likely oil export revenues. That, however, assumes oil is at $120 a barrel. Should it fall further, there will be a lot fewer petrodollars to pay for all those projects. @Email:[e-mail]