Saturday, January 25, 2014

Emerging market crisis?

by Michael Roberts

Back in early December, I wrote that injections of money by the major central banks of the world through what is called quantitative easing was causing not inflation of prices in goods and services but instead in financial assets.  Stock markets were booming as banks and (large) companies were flush with cheap credit and cash.  Rather than lend to businesses or invest in new productive capacity, they preferred to look for higher returns in fictitious capital (property, stocks and bonds).  House prices have jumped back up everywhere, while governments get the banks to buy their bonds and keep interest rates low.  It’s a circular process in fictitious capital expansion.

One extra aspect of this was the boom in commodities (base metals, gold, food crops etc) for emerging economies, where most of the world’s raw materials for production are.  Also, as yields are much higher for bonds and equities in emerging economies, much of this cheap credit flew to these economies, driving up financial asset prices and to some extent, inflation of goods prices too . Because central banks there were not ‘sterilising’ these foreign currency cash inflows, they led to sharp rises in domestic money supply and falling interest rates that engendered property price booms and rising inflation.

But then last summer, the US Federal Reserve, the leader in quantitative easing, decided that the time had come to begin to ‘exit’ from these injections (see my post,  The Fed announced that it would taper its programme of purchases in the autumn, just ever so slightly from $80bn a month to $70bn.  It was still injecting, but at less of a rate.  In the event it delayed its ‘tapering’ until December.  But it has now started.  It’s only a small reduction so far but the financial market investors see this as the thin end of the wedge.  They are expecting QE to end this year and then for interest rates to start to rise.  As a result, there has been a sharp drying up of credit to emerging markets and also into commodities (the gold price has plummeted).  As I said last December, “If the Fed reverses QE as it will start to do shortly, then flows to EMs could turn round and cause a nasty credit squeeze.”

The change in Fed injections is marginal but it is the emerging economies which are at that margin.  They are the first to be hit, but especially those economies that depend heavily on trade, but are running deficits because they were trying to maintain living standards and avoid austerity.  Some of these economies already have large debts owed to foreigners and the cost of servicing those debts will rise sharply.  Foreign investors got even more worried and tried to get their assets out of local currencies and into dollars or euros – this is called capital flight.  So the currencies of those economies with big foreign debts like Argentina, Turkey, South Africa, Brazil have plummeted in short order.

Argentina is suffering the most because it already defaulted on its debts back in 2001 and has had large deficits on its balance of payments with the rest of the world.  The irony here is that many Keynesians like to use the example of Argentina as a way out of the austerity that the likes of Greece or Portugal are suffering in the Eurozone (see my joint paper with G Carchedi, The long roots of the present crisis).  Do what Argentina did in 2001: default on your debts, leave the euro and devalue your currency, then you can get growth, the argument went. Well, the proverbial chickens have come how to roost on that strategy.

As a result, what were originally named by the Goldman Sachs guru Jim O’Neill as the BRICS, (Brazil, Russia, India, China and South Africa) as the supposed saviours of global capitalist growth, have now turned into the ‘fragile five’ (India, Brazil, Indonesia, Turkey and South Africa).  Not quite the same group, as many of these struggling emerging economies depend on selling, not so much manufacturing goods or services, but agricultural or metals commodities.  This is particularly the case for the likes of Argentina, Brazil, South Africa, Chile.

And who is the biggest importer of these exports? – China.  China’s economy has been slowing down as the government tries to control an excessive expansion of credit into property and infrastructure building, exaggerated by what is called a shadow banking sector.  Just as in the credit boom of the US and Europe before the global credit crunch of 2007, the credit boom has been conducted off the balance sheets of the banks and instead by financial intermediaries that until recently were not being regulated.  This led to an explosion in credit.  Now that is being reeled back, but as a result investment in infrastructure is dropping back.  And the demand for raw materials in construction, copper, iron ore, steel, coal etc is also waning relatively.  The result is a loss of demand for the exports of Australia, Chile, Brazil etc.

So it’s a double whammy: a tightening of credit from the West and a fall-off in demand from the East.  What now?  Well, I reckon China’s slowdown may be limited: it can get control of credit excesses and bail out its banks if necessary without imploding, as it has plenty of reserves and the power of directing investment. But economic growth there will still slow for the rest of this year.  So the emerging economies remain in a squeeze.

Ironically, now everything depends on the advanced economies picking up the growth baton.  Will the advanced economies grow fast enough to get employment and incomes up and also provide new demand for the products of the emerging economies to get them out of their fix?  The IMF has increased its forecast for global growth for this year based on faster growth in the advanced economies and that figure is still below previous trend growth.  But if the largest emerging economies now grind to a halt, even that forecast may be proved optimistic.

No comments: