AFR discovers Mining GFC, declares it over

A good piece from Patrick Commins at the AFR today:

Is an upcoming rate rise in the US about to help spark the next emerging market mini-crisis?

Some analysts think so. With the quasi-panic of January and February fresh in our minds, analysts at Morgan Stanley this week caused waves with a provocative piece of research titled The Great Bear Rally Unwind, in which they called an end to the emerging markets rally of recent months.

…The broker’s comment touched a nerve because if there’s one thing that is supposed to scare investors in emerging markets, it’s the spectre of a rate rise in the US and the boost it could give to the greenback.

Why? For one, companies across the emerging markets zone owe more than $US3 trillion in US-dollar denominated external debt – a massive increase from $US0.8 trillion at the end of 2004, on RBA numbers. A stronger greenback makes servicing those debts harder, and undermines investor confidence. It’s a real issue.

…The other strand is that commodities are quoted in dollars, which means a stronger US currency pushes down the demand for raw materials and hence their prices. That hits the terms of trade of commodity-producing economies, of which there are many across the emerging world.

…But recent history is running counter to that theory. Oil – a key commodity across emerging and developed markets – is no longer slavishly tracking the greenback. Over the past month crude prices have continued to forge higher despite a stronger dollar…A more stable oil price is a big stabilising force.

Another factor supporting emerging markets is that everybody who was going to sell out of the region has already done so, says the godfather of emerging market investing, Mark Mobius, executive chairman of Templeton Emerging Markets Group.

…”Retail investors in particular have been reducing emerging markets exposure for the past two years,” agrees Philip Moffitt, Goldman Sachs Asset Management’s head of fixed income for Asia-Pacific.

…Recent emerging market mini-crises have been driven by fears of the US Fed tightening policy, concerns around China and falling oil prices. But each time “high-yielding or EM assets have bounced back quickly,” Moffitt says.

…There are reasons for emerging market investors to be worried – China’s economic transition and growth being a prime example. But, at least for now, you may be able to strike the Fed and the mighty US dollar off your list of worries.

This is the first piece in the process of the Mining GFC written by an AFR journo that I’ve seen. It’s a good one even if it’s five years late. I have a rebuttal:

  • this is essentially a “decoupling” argument; oil decoupling from the USD and other commodities, plus China and EMs decoupling from Fed tightening. In my experience, decoupling arguments arrive at about five minutes to midnight for the global business cycle. Does anyone recall that “decoupling” was everyone’s favourite theory in early 2008? It was exactly the same as EMs were supposed to “decouple” from Fed tightening and drive growth all by themselves. That went well, not;
  • the FED is still tightening and it’s objective is to “normalise” policy, code for returning rates to 3% and the NAIRU. The only thing preventing this tightening being more rapid is EM convulsions. But as each one passes the tightening will resume. Eventually, almost definition, the Fed is going to go one step too far. Fighting the Fed is ALWAYS a bad idea;
  • the USD is still in a bull market owing to point two, as well as the lousy state of other major funding currencies. Let’s see what happens in the next few months in Japan as its growth and inflation stall on a higher yen. It’s not putting about hysterical warnings about growth at the G7 for no reason, it is preparing the ground for more printing. It has nowhere else to go. Europe is not out of the same woods plus it has its various political challenges. This seriously increases upwards pressure on the USD;
  • and then there’s China. The Mining GFC feedback loops have been pushed out owing to its stimulus as well. But that is not going to last. By year end I expect we’ll be back where we were late last year. That means more commodity price falls, including oil, and more yuan devaluation.

Basically, the Mining GFC is too big to be over. It is driven not just by the cyclical feedback loops nicely explained by the Mr Commins but by the structural imbalances that dog the global economy in the form of an unwinding Chimerica. That is, China is over-indebted and cannot drive commodity demand any longer. The US is over-indebted and cannot drive global consumption any longer either. Both facts totally unravel emerging market business models.

Central banks will fight it but they can only keep it bay by making it worse and before too long they will lose. The real solution lies with fiscal authorities and the push for restructuring as well as massive infrastructure investment.

When that comes via helicopter money the Mining GFC will be over. But that only arrives after the next crisis.

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