Reject the Consensus: 'V' Means Vulnerable

As East Asian governments are concerned about the recovery's staying power, they have been extremely reluctant to increase interest rates from the super-low levels set while dealing with the financial crisis. But inflation is pushing against this strategy. Inflation seems to be accelerating everywhere, even though most governments emphasize relatively low inflation levels and say current economic activity levels are not high enough for an accelerated round of inflation.

I have argued many times that this line of thinking is wrong. Keeping interest rates low is a mistake and will have negative consequences down the road.

Australia is probably the only country doing the right thing on monetary policy. Its central bank raised its policy rate to 4.5 percent – twice China's. Australia's unemployment rate is higher than China's and its growth rate is only one-fourth as high. But inflation rates are about the same in each country.

Even though Australia's central bank cites economic strength as a reason for an interest rate hike, there is little doubt that it's actually based on concerns about overheating in the property market. When the property market rolls over, Australia's economy will soften. The central bank knows that if it doesn't act now, at a time when commodity prices are high, the property market may crash if prices for the nation's exported natural resources fall. Australia is clearly thinking ahead.

Negative news out of Europe is centered on the Greek debt crisis. The market is worried about Greece's solvency and a bailout package that would require a spending cuts equal to 10 percent of GDP. But the social backlash could trigger a political change. So Greece is better off defaulting.

More important than Greece's crisis is Britain's economic weakness. Its fiscal budget deficit exceeds 10 percent of GDP and its economy stagnated, showing just 0.2 percent GDP growth in the first quarter. Britain is not benefiting from the global trade recovery because it hollowed out its industries during the financial boom and grew a massive property bubble that's since deflated. Now, its economy depends on government spending to stay afloat. It could face a debt crisis like Greece's, prompting the central bank to print money to pay government bills, which could lead to a crash for the pound that may feature prominently in the next global crisis.

One factor is common globally: the central role of stimulus. Most governments have been counting on stimulus to resuscitate their economies. As I have argued many times before, an economy tends to have a major misalignment of supply and demand after a big bubble phase. An adjustment takes time.

Trying to regenerate high growth through stimulus, rather than patiently waiting for a market realignment, leads to rising inflation rates. When inflation sparks panic, rapid tightening becomes inevitable. And that triggers another crisis. I'm afraid this is exactly what's in store for 2012.

Andy Xie is a board member of Rosetta Stone Advisors Limited