Thursday, August 29, 2013

Emerging Market Rout

Ambrose Evans-Pritchard writes:

Mirza Baig from BNP Paribas advises them [the BRICS] to embrace devaluation, calling it futile to defend quasi-pegs. "The costs of fighting are spiralling out of control," he said. 
Mr Baig said foreigners bear 90pc of the currency risk in Malaysia, 81pc in Thailand, 79pc in Korea and 74pc in India. So let them take the haircut. Should these countries take that course, they will inflict a deflationary trade shock on the West. The eurozone is in no fit state to handle that. Nor is Britain. 
We are in entirely uncharted waters. Emerging markets were less than 15pc of global GDP in the early 1980s, when tightening by the Volcker Fed brought Latin America crashing down. That was an ugly episode for Western banks, but easily contained. China was then in autarky, shut off from the world. The Soviet Union and its satellites formed a closed system. 
The picture was already very different by the mid-1990s, when ex-Communists had joined the party. By then emerging markets had grown to a third of global GDP, big enough to rock the boat, as Fed chair Alan Greenspan discovered after Russia's default in August 1998. 
Mr Greenspan became worried enough to canvas Fed governors on the need for a response at the Jackson Hole conclave that month. The Fed cut rates in September but it was not enough to stop the crisis spinning out of control as currencies crashed across East Asia, and the pre-EMU "convergence play" in Europe reversed violently. 
The New York Fed was forced to intervene in October 1998, rescuing the hedge fund Long Term Capital Management. The Fed cut rates again in October and November. Mr Greenspan said "the probability of systemic collapse was sufficiently large to make us very uncomfortable about doing nothing". 
If the stakes were high then, they are higher now. Emerging markets are half the world economy, according to IMF data. The "power ratio" is no longer 1:2, it is 1:1. Those who fell in love with the BRICS and mini-BRICS in the boom were entirely right to claim that an economic revolution was taking place. 
Yet all we heard from Jackson Hole this time were dismissive comments that the emerging market rout is not the Fed's problem. "Other countries simply have to take that as a reality and adjust to us," said Dennis Lockhart, the Atlanta Fed chief. Terrence Checki from the New York Fed said "there is no master stroke that will insulate countries from financial spillovers”. 
The talk for Fed corridors strikes me as dangerously insouciant. The bank has made a series of errors over the past six years, the result of a "closed macro-economy model" that fails to take full account of global interactions. It failed to anticipate how jamming on the brakes before the Lehman crash would trigger a scramble for dollars, igniting a conflagration. The bank played a key role in setting off later spasms of the EMU debt crsis with hawkish talk, each time forced to retreat later. 
"The big risk is that Fed tapering will spark a rush for US dollars. That is when the Fed will stop being complacent," said Lars Christensen from Danske Bank. "Central banks around the world think they have been doing something they shouldn't do with all this stimulus, and they want to unwind it as quickly as possible. But the danger is that they will go too far and trigger a relapse like 1937."
 Read the whole thing.

The basic problem is one of competition, which is ultimately a question of price and value. A country can compete as to price/value by offering low wages and/or high efficiencies. Costs of living in the United States prohibits us from competing via wages when compared against most countries. However, overweening government regulations and laws cripple U.S. firms when it comes to higher efficiencies--particularly against countries like China or Korea which can also offer high efficiencies. The approach by the federal government (and many state governments) has not been to reduce the impediments to efficiencies, but to focus on lower wages--which have stagnated for the past several decades among the middle-class.

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