EM crisis as GFC phase III

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Find below a excellent interview with the Governor of the South African Reserve Bank, Gill Marcus, with which I agree, that the emerging markets crisis (yes, it is one) is only the latest episode in the GFC as the various policy responses push the consequences around the world:

This may be right but it is also tactical analysis, not strategic. The more fundamental cause of the entire process is captured at FTAlphaville:

There is a destabilising force pounding its way through the global economy, generating untold chaos in its wake. You can’t see it, you can’t touch it, and you definitely can’t kill it. At best, you can scare it away (temporarily). Sometimes, if you’re lucky and it serves your interests, you can woo it back as well.

What we’re talking about, of course, is idle capital, the sort that greedily seeks out guaranteed returns without any respect for conditionality, commitment or risk. Something also frequently referred to as ‘hot money’.

…The story is wonderfully summed up Frances Coppola at Pieria this week.

As she argues, capital controls or global cooperation could be the best policy action we have for stamping out the plague of such faux ‘hot money’ friends.

Though, as she also argues, the trick then becomes filtering out the bad friends from the good friends, without necessarily putting off or closing yourself off from new friends entirely:

The problem really is where the flows go. If they go into new business development, creating jobs and economic activity that eventually is self-sustaining – sort of “priming the pump” – then they are to be welcomed. But if they go into real estate and/or construction (whether housing or infrastructure), or into funding consumer or government spending, then they could be creating sustainable economic growth – or they could be blowing up potentially damaging bubbles. So the challenge is to determine when inward flows are helpful and when they are not. And this is not easy for governments to do.

This, needless to say, can be a difficult task for even the most established and discerning governments:

It is very easy for even supposedly responsible governments to make the mistake of confusing inflows of hot money due to investors reaching for yield or safety with genuine foreign direct investment. In my view this mistake is currently being made by the UK government, which is hanging both its economic and its election strategy on house price appreciation driven by demand for high-end London property by overseas investors, most of whom have no intention of living in the UK and are simply treating prime residential real estate as a safe high-yield investment. They have no commitment to the UK and will sell up when better opportunities come along – and when they do, the housing market will collapse. The right-wing think-tank Civitas has proposed a mechanism for restricting sales of prime residential property to overseas investors. It should be taken seriously.

Hence why those economies that didn’t take hot money inflows at anything other than face value — i.e. didn’t judge them to indicate an amazing improvement in their underlying fundamentals or mistake them as anything other than false flattery — are likely to fare much better at this point in the cycle.

As Coppola notes:

It is fair to say that some emerging market countries are better able to cope with the present market turbulence than others, and this is directly related to the soundness of their macroeconomic and fiscal policies in the last few years. Those countries that have used the QE-driven inflows of capital since 2008 as an excuse to pursue highly expansionary monetary and fiscal policies are already facing the possibility of severe economic contraction, inflation and even debt default as their currencies collapse:
All of which begs one question. Should some of the blame associated with what happens when false friends leave be directed to those who sent them your way to begin with?

According to Coppola, on the basis that the flows were probably incentivised by the Fed’s unilateral QE actions — the Fed using QE as the primary tool to mitigate the harmful effects of idle capital on home turf — then the answer is yes, the Fed should be blamed, and it should also be held accountable for any cross-border chaos its actions create.

As Coppola notes:

In other words, the Fed should not “go it alone” on monetary policy decisions if those decisions would cause disruptive capital movements and place at risk global financial and economic stability. Yes, there are basket case economies out there: no-one is suggesting that the Fed should construct policy to help them avoid the consequences of their stupidity.But if the Fed’s policy puts the global economy or financial system at risk, the US will be behaving even worse than Argentina and Venezuela. After all, their stupidity only places themselves at risk. The US’s “self-determination” could place the entire world at risk. The IMF warned the US that tapering QE would make the financial system riskier, and that policymakers in other countries might have to intervene to protect their economies. And there have been calls from the World Bank as well as from central bankers and finance ministers in significant emerging market economies for co-operation between central banks as suggested in the IMF’s paper. So far this has fallen on deaf ears.

Coppola concludes that cooperation between central banks is ultimately preferable to capital controls being imposed by EM states to prevent capital leaking out — because even if they were effective, once they are imposed they’d be very difficult to reverse. It’s also hard to disagree that overall free-movement of capital is economically desirable.

That may be ideal but it’s a delusion. As Doug Noland has documented so well for a decade, Anglospheric central banks, and the Fed in particular, do not see it that way. Bernanke (and Greenspan before him) created the very crisis that history will credit him with resolving through the embrace of freewheeling capital market innovation that has hot money at its core. Western central banks rely on these flows to reflate each more destabilised cycle and very little has been done to contain it.

EMs will have no choice in the end but to cut off the flows if they no longer wish to be blown up every cycle. It’s not anti-capitalist to do so. It’s preserving capitalism from a rampant speculator that is tearing it apart bubble by bubble.

Houses and Holes
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Comments

  1. “They have no commitment to the UK and will sell up when better opportunities come along – and when they do, the housing market will collapse.”
    The same, I think, is likely to be true of Australian and Canadian property, but more than that, once a crisis hits in China, I suspect this money will be sucked back into the motherland, in the same way as the beach house is the first thing to be sold when things get tough.

  2. Another most quotable summing-up from H&H (he’s really good at this)

    “…….Bernanke (and Greenspan before him) created the very crisis that history will credit him with resolving through the embrace of freewheeling capital market innovation that has hot money at its core. Western central banks rely on these flows to reflate each more destabilised cycle and very little has been done to contain it.

    EMs will have no choice in the end but to cut off the flows if they no longer wish to be blown up every cycle. It’s not anti-capitalist to do so. It preserving capitalism from a rampant speculator that is tearing it apart bubble by bubble……”

    Minor nit-pick – a typo – the word “Anglosheric” in the second-last para is missing a “P”. It bothers me because these last 2 paras should get copied and pasted widely all round the WWW.

    • “Western central banks rely on these flows to reflate each more destabilised cycle and very little has been done to contain it.”

      Yers Phil
      But why is there no support whatsoever for sensible proposals to control these flows into Australia put forward by some very sensible contributors to this site?

      The US sourced modern economic thinking, to which our economic policy makers and commentators are all slaves, is just baloney based on false premises.

      • I am agnostic on that. No-one is forcing anyone to borrow money. I think it is possible to have local fiscal and regulatory settings that make freedom of capital movement a benefit rather than a problem.

        It is local conditions that mean liquid investment goes into unproductive asset Ponzi rather than productive capital.

        I would argue that Australia could be the Texas of the South Pacific; rather than some sort of perverse combination of the UK of the South Pacific without the advantage of having a massive global finance sector cluster as the source of weightless primary income, along with a “Dutch disease” phenomenon relating to far-from-weightless commodities.

        I don’t see asset bubbles wrecking the economies of Southern and heartland USA – I see a combination of low finance costs AND low asset costs producing an amazing phenomenon of increased discretionary spending and maximum investment in productive capital.

  3. “According to Coppola, ……….,,the Fed should be blamed, and it should also be held accountable for any cross-border chaos its actions create.”

    The capital flows hot money problem is not the Fed’s fault, they are driven to do what they think will serve US interests. They can’t be criticised for that.

    The fault lies with all the dim economic clones reciting the simplistic mantra that without controls on capital, capital will magically flow from those who have it to those who need it and the world will be dripping in honey and blossoms.

    Having said that ‘controlling capital’ is not really the objective – capital is too abstract – the best objective is regulating the types of transactions that drive capital flows.

    Without transactions to cling to, capital finds it hard to fly.

    This can be done relatively easily.

    For example:

    Govts – especially the fiat producing type should never issue govt securities to foreigners or permit them to be held by foreigners. i.e if a govt wishes to borrow for its expenditures it should be limited to raising money from locals. That would provide a nature limit on govt funding by borrowing as they compete for savings and drive up yields.

    (Note: Yes b_b and Peter Fraser I know they can spend without borrowing due to fiat currency but I will let you explain why that could be a good thing 🙂 )

    The banking sector should be prohibited from borrowing money from foreigners related to residential mortgage lending. There is no real reason countries need foreign savers to fund their housing construction. If they do they have major problems.

    If foreigners really want to invest in residential real estate let them do so directly – RMBS or direct to the specific borrower, if they make a mistake they wear the problem. If needs be even this can be locked down.

    Sure there are plenty of other transactions that might require attention – bank borrowing from OS for commercial real estate etc, corporate borrowing from OS, shares sales to foreigners and selling assets but the big ones – residential real estate and govt securities – are a good place to start. In total they probably exceed 1T.

    Capital movement is fine but completely free movement is only for ideological fanatics.

    • ” I know they can spend without borrowing due to fiat currency”

      Yep I’m still waiting for the explanation of how the resulting CAD is financed without asset sales, more debt, and/or a decline in the value of the currency.

      • Well they can but they won’t, there will always be an entry on the other side of the ledger that must be covered either by taxes raised or by bonds sold. Governments won’t just print without accountability.

        Sure, as the government debt grows larger it puts downward pressure on their fiat currency, which makes exporters more competitive.

      • Peter:

        “……as the government debt grows larger it puts downward pressure on their fiat currency, which makes exporters more competitive…..”

        Which advantage is pissed away in increased cost of non-productive assets, particularly land.

        I am watching Southern and heartland USA benefit from monetary union with fiscal and regulatory lunatic States, like Germany is benefiting from monetary union with Spain, Portugal, Greece etc.

  4. “According to Coppola, on the basis that the flows were probably incentivised by the Fed’s unilateral QE actions — the Fed using QE as the primary tool to mitigate the harmful effects of idle capital on home turf — then the answer is yes, the Fed should be blamed, and it should also be held accountable for any cross-border chaos its actions create”.

    Don’t really agree with that.

    The responsibility for the “hot money flows” lies with countries which have followed high saving models and Western/Japanese corporates who have an unrealistic hurdle for investment.

    – The Fed was forced into QE because it could no longer cut rates. It couldn’t cut rates because the Fed Funds rate was too low coming in to the crisis. The Fed Funds rate was too low coming into the crisis because the global saving glut was pinning down the world real rate.

    – 2008 should have been a warning to emerging markets not to take a gigantic short position in the US dollar.

    – They didn’t heed the warning because the Fed bailed them out through swap lines and other measures.

    – Emerging markets doubled down and took on an even bigger short position on the basis that the Fed would always provide global liquidity and the US dollar would forever be weak

    – Fed didn’t force them do this. Neither did it force them to continue with their stupid official and unofficial pegs when EM growth rates were in double digits and the high income world was depressed. This was the main reason capital flooded EM’s. Their currency’s were undervalued.

    EM’s should grow up and take control of their own destiny.

    • How can they have high saving models of USD without the US printing the money one form or the other. The US chose to have super-low interest rates. Then it chooses QE. Nobody made them do it. We choose to flog assets. it’s exactly the same thing except that the US has one more step in the process.
      The US has run a CAD for a long time. That is its choice. It doesn’t have to. The whole western world chooses debt and over-consumption.
      It’s amazing to see commentators blame people who conserve and save for these crises yet next thing we will have the same people carrying on about pollution and the environment.

      • What about inflation? If the Fed chose 0% rates and QE how come post GFC US inflation has averaged 1.5%. The lowest post war, I think.

        The people with the agency in all this (those who set the whole thing in motion – ie super low rates/asset bubbles/ crashes etc.) are 1. The Chinese billionaires who decided to adopt a Singapore model for a country of 1.3 billion. and 2. Western/Japanese executives who sit on cash and refuse to invest.

      • Sweeper, read “Inflation and Debt” by John Cochrane.

        http://www.nationalaffairs.com/publications/detail/inflation-and-debt

        Inflation will come – there is a tipping point for it that just hasn’t been reached yet.

        The “Western/Japanese executives who sit on cash and refuse to invest” are just acting rationally in a system of highly perverse incentives. BTW the top 1% are doing very nicely, gouging economic rent out of everyone else’s misfortune both now and future.

    • Again I think we need to actually understand what QE was and what it’s purpose is.

      Whilever credit growth in the US has been insignificant or negative, QE has simply been an asset swap between the Fed and it’s member banks, as the banks have left the funds they received on deposit as reserves at a rate of interest higher than most savers can get for at call or even 6 month funds.

      There are also questions about the values of the assets purchased by the Fed being a value transfer to restore bank’s solvency.

      The QE may also have been the mechanism for deficit funding duringthe GFC.

      But I would argue that it is the level of interest rates which has caused the hot money to flow, not QE itself.

      I would expect the hot money flows to have happened if interest rates were at current levels in the US even if there was no QE. In the circumstances of the US economy for the last 5 years, QE was not necessary to achieve low rates.

      • Mig, I think I might have been too easy on Turkey the other day. While the currency rout has been stopped for now, further investigation led me to discover that the private sector there has been very silly in it’s debt denomination (I only checked the public balance sheet):

        http://www.theatlantic.com/business/archive/2014/02/everything-you-need-to-know-about-the-emerging-market-currency-collapse/283590/

        Which sets it apart from other emerging markets, who learned from previous crises not to become overly indebted in foreign currencies. I suppose I need to retract my previous statement in this case! Crisis not guaranteed, but on looking deeper it does seem Turkey has the potential for a replay of previous problems.

      • migtronixMEMBER

        @Macro: Hmmm thanks for digging into that and reporting back 🙂

        I thinks its the same story with Romania etc the private sectors of which have been borrowing in EUR.

      • Ironically, low interest rates are actually stimulating real economic activity in Southern and heartland USA where there are no land price bubbles to inflate. Every mortgage refi is for the purposes of paying it off more quickly or reducing the size of repayments; not for the purpose of cashing out inflated “equity”. This has a similar econ stimulus effect to “equity withdrawal spending” but without the hangover.

  5. You guys need to expand your reading circles and step a little outside the musings of self interested western economists.

    I’d suggest you start with the following piece:
    Zhou Xiaochuan: Reform the international monetary system
    http://www.bis.org/review/r090402c.pdf

    Read it with an open mind, its well worth the time!

    • thanks – that is a good concise summary of the argument for change.

      Opposition to change is likely from the US. Only China, working closely with countries not hot-welded to the US ( i.e not Australia or the UK) is likely to be able to drive such a reform.