An Emerging Market Crisis?

At first Prof Krugman had a rather reassuring view on the INR weakness even concluding "So at first examination this doesn’t look like as big a deal as some headlines are suggesting". He also had a good explanation for the current weakness of em assets: "We more or less know the story here. First, advanced countries plunged into a prolonged slump, leading to very low interest rates; capital flooded into emerging markets, causing currency appreciation (or, in the case of China, real appreciation via inflation). Then markets began to realize that they had overshot, and hints of recovery in advanced countries led to a rise in long-term rates, and down we went."

But here is a list of op-eds that are much less optimistic and that suggest further adjustments may be in the cards.

Back in July Trouble in emerging market paradise by Nouriel Roubini who concluded "These factors explain why growth in most BRICS and many other emerging markets has slowed sharply. Some factors are cyclical, but others – state capitalism, the risk of a hard landing in China, the end of the commodity super-cycle – are more structural. Thus, many emerging markets’ growth rates in the next decade may be lower than in the last – as may the outsize returns that investors realized from these economies’ financial assets (currencies, equities, bonds, and commodities).

Of course, some of the better-managed emerging-market economies will continue to experience rapid growth and asset outperformance. But many of the BRICS, along with some other emerging economies, may hit a thick wall, with growth and financial markets taking a serious beating."

A bumpy ride for emerging markets from Laura Tyson with a key message "when the Fed tightens monetary policy to manage macroeconomic conditions in the US, there are large unintended spillover effects on capital flows to emerging markets". Though EM are nowadays better equipped to weather the storm than in the past she mentions "some countries are at risk, especially those with large current-account deficits, large foreign capital inflows relative to the size of their financial markets, and low foreign-exchange reserves. Among the most vulnerable are Turkey, South Africa, Brazil, India, and Indonesia – a group that Morgan Stanley researchers have dubbed the “Fragile Five.""

The end of the emerging market party from Ricardo Hausmann who concludes "The same dynamics that inflated the dollar value of GDP growth in the good years for these countries will now work in the opposite direction: stable or lower export prices will reduce real growth and cause their currencies to stop appreciating or even weaken in real terms. No wonder the party is over."

Danny Leipziger on Brazil's growth imperative which states: "Brazil has lost its swagger. Growth estimates for this year put Latin America’s largest economy above only Venezuela and El Salvador in the region, and the outlook for next year is not much better. Brazil’s currency, the real, has fallen to its lowest level against the US dollar in more than four years, compelling the government to pump billions of dollars into the foreign-exchange futures market and raise interest rates to deter capital outflows – just a few years after imposing a new tax to deter inflows."

Abenomics for Asia by Yuriko Koike who concludes: "Sixteen years ago, the Asian financial crisis erupted, following the Thai government’s decision to float the baht in the face of speculative attacks. The response of governments to that crisis has shaped much of the region’s economic policymaking ever since. If Asia is to avoid another crisis on a similar scale, or lost decades of growth, its governments will need to embrace the type of all-encompassing reforms that Japan is undertaking. Abenomics, it seems, is for everyone."

The Global QE Exit crisis by Stephen S. Roach who concludes: "Where this stops, nobody knows. That was the case in Asia in the late 1990’s, as well as in the US in 2009. But, with more than a dozen major crises hitting the world economy since the early 1980’s, there is no mistaking the message: imbalances are not sustainable, regardless of how hard central banks try to duck the consequences. Developing economies are now feeling the full force of the Fed’s moment of reckoning. They are guilty of failing to face up to their own rebalancing during the heady days of the QE sugar high."

And finally Brad DeLong commenting on Mrs Tyson's piece above sums it up nicely: "The fear is, as Rudy Dornbush used to put it, that India and other emerging markets are right now not North Atlantic but rather South American economies".

A case of multiple equilibria? One day half full and filling up and the next half empty and leaking fast.

Tracking the Global Recession

A great timeline of the crisis starting in Feb 2007. With hindsight so many canaries in the coalmine. (H/T Crossingwallstreet)

A Nice Little Conversation

Ineichen has a nice three parts conversation on the crisis, finance, asset management, hedge funds, regulation, bananas. Full of re-usable quotes such as "Life is a tragedy for those who feel, but a comedy to those who think" or "It ain’t what you don’t know that gets you in trouble. It’s what you know for sure that just ain’t so."

Here is part 1
Here is part 2
Here is part 3

What Went Wrong

Great little wrap up on the crisis from Econbrowser. He highlights the US Treasury's recent proposal for reform of the financial system:
"

• Introduce a legal mechanism whereby large financial institutions that are not commercial banks (such as AIG or Bear Stearns) can be liquidated in an orderly manner without bankruptcy or bailouts, analogous to the authority that the FDIC currently has to take over failing banks.
• Subject the banklike functions of investment banks and structured investment vehicles (that is, the activity of borrowing short and lending long) to the same capital requirements as standard banking.
• Require either mortgage originators or the mortgage securitizers to retain 5 percent of the product they create. I would take that idea a step farther, endorsing Princeton Professor Alan Blinder's proposal that originators and securitizers should each hold 5 percent.
• Move the trading of financial derivatives like credit default swaps to centralized exchanges where they would be subject to a robust regime of regulation including conservative capital requirements, margins, and reporting requirements. To the Treasury's proposal, I would also recommend adding stop-loss provisions that regulators could use to limit the promises made and losses suffered by systemically important financial institutions as a result of their trading in financial derivative contracts.
• Set guidelines for individual compensation systems at systemically important financial institutions in order to better align the personal rewards of traders with the interests of shareholders and the public."

Back to Normal

Brad DeLong informs us: TED spread is back to normal, pre-crisis level.

"The End of the Financial World as We Know It"

A famous investor recommends this NYT article. A great read indeed on the tyranny of the short term, moral hazard, the role played in the current crisis by rating agencies and regulators such as the S.E.C. I did not know that "The commission’s most recent director of enforcement is the general counsel at JPMorgan Chase; the enforcement chief before him became general counsel at Deutsche Bank; and one of his predecessors became a managing director for Credit Suisse before moving on to Morgan Stanley." The authors use great images:
On the suspension of "mark to market" accounting: "gorge yourself for months, but refuse to step on a scale, and maybe no one will realize you gained weight"
On credit-default swaps: "Call it insurance if you like, but it’s not the insurance most people know. It’s more like buying fire insurance on your neighbor’s house, possibly for many times the value of that house — from a company that probably doesn’t have any real ability to pay you if someone sets fire to the whole neighborhood."

The Aftermath of Financial Crises

Very interesting paper by Carmen Reinhart and Kenneth Rogoff. The Economist has the key findings here. Looking at the table below it appears that the current correction in US Stock prices from their peak is now very close to the average change during severe financial crises. But it could last longer.