It’s time to sell Russia. The end of the easy money era and the war in Georgia don’t, at first glance, seem to have an obvious connection. But they are linked. Bear with me, and I’ll explain why.

Cheap money gave us many things, including a global property bubble, and a £1.4 trillion debt mountain for UK consumers. Another noticeable trend was a taste for exotic new investment classes, from Iraqi government bonds to obscure derivatives.

All of these trends were the result of falling risk aversion. Investors believed that central bankers, lead by Alan Greenspan, now had complete control of the global economy. Globalisation would ensure economic growth went on forever. And if it didn’t, a soft landing could be engineered by judicious use of the emergency interest-rate cut button on Greenspan’s miraculous economic control panel.

As investors became bolder, and focused entirely on returns, rather than risks, one brave new investment class, invented entirely by a man working at Goldman Sachs (NYSE:GS), benefited more than most.

It was called the Brics…

The Brics were a great investment, when risk didn’t matter

The Brics – as you probably know by now - was a catchy acronym for Brazil, Russia, India and China. Jim O’Neill at Goldman Sachs coined the term in 2003, and predicted great things for these four countries.

And he was right. They’ve all benefited from booming commodity prices (in the case of Brazil and Russia), or booming US consumption (China), or the outsourcing boom (India). But another point has also worked in their favour.

Low interest rates pushed returns down too. As more and more money chased each new investment opportunity, yields fell on all major asset classes. That drove investors, particularly adventurous new players like hedge funds, into ever-more outlandish investment areas.

Risk took a back seat – political risk in particular. No one batted an eyelid at putting money into once-frontier markets. “China? Sure, it’s a totalitarian regime. And yes, communists have never quite got to grips with the idea of privately-owned property. But this is a globalised economy now. The government won’t want to upset investors. Especially not ahead of the Olympics.”

Why China and Russia have now become very risky for investors

But free and easy money has vanished now. Now some of the best returns you can get are in good old-fashioned hard cash. And when your best returns come from risk-free assets, suddenly things like political risk matter again.

That’s bad news for most emerging markets. And it’s a worry for the Brics too, all of which have seen their stock markets take a hit this year.

But it’s worse for China and Russia. Brazil and India have their problems, and plenty of them. India in particular has a fractious democracy, terrible infrastructure and chronic corruption. But at their core, they believe in democracy as a model for society, so the chances of dangerous social upheaval are comparatively low.

In China, the chances of a civil breakdown are higher. Economic problems tend to lead to unrest. The uprising in Tiananmen Square occurred at a time of high inflation, for example. We’ve more on China and the troubles it faces in the current issue of MoneyWeek. If you’re not already a subscriber, you can get your first three issues free.

But Russia’s probably the most risky for investors. The country is a basket-case in many ways. It has appalling social problems including high levels of alcoholism, HIV infection and suicide. And while surveys suggest that the Chinese population seems largely comfortable with the idea of capitalism, ordinary Russians seem to pine for the good old days.

Read the full article

Source: How the Cheap Money Era Led to the War in Georgia