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Investors have been rattled by the recent collapse in the currencies of Turkey and Argentina. And the question on everyone's mind is. Is this the start of something bigger? Should we be worried about a global emerging markets crisis?
There is a history of emerging markets crisis. And we can learn something from looking at the pattern of crises in the past. And the pattern is this. After a period of loose liquidity, money flooding across borders from the rich countries to the developing world, you have a tightening in the US in particular. And money pulls back and causes a crisis.
This happened in 1982. It happened in 1994, '95. And low behold, we are at the end of a period of huge monetary loosening. And the Fed, the US central bank, is raising interest rates. So should we be worried about a repeat of past problems?
When the crisis hit the rich world in 2008, the response from policymakers was to throw money at the problem, extremely ample liquidity, low interest rates, and so lots of continued money creation. Where did all that money go?
Well, it was hard to get returns in the rich world. So as in past episodes, money floated around, including two emerging markets in a quest for yield. And not only that, you had emerging countries too trying to stimulate, in particular China. Now, all of that meant that you continue to have growth on a global level.
Emerging markets did reasonably well after the crisis, but on the back of rising debt. So the debt that had accumulated in the rich world before the crisis was, to some extent, picked up and shifted onto balance sheets in the emerging world, in emerging countries, corporates in particular.
Should investors worry? Well, it depends. Some countries clearly have got into trouble. Turkey and Argentina accumulated debt, let growth be based on foreign capital, and had a large current account deficit. Which means that they are spending more than they produce. They're borrowing a lot of money from abroad.
If that money stops flowing in, you get what is called a balance of payments crisis. And that is always painful. You need a steep adjustment to produce more, export more, consume less, import less, to make that balance of borrowing shrink.
Not all countries are in the same vulnerable position. There is much more difference between emerging countries than there has been in the past. Some countries have current account surpluses or balanced current accounts. Countries have got better and are trying to borrow in foreign currencies or peg their currency to a foreign currency like in the past. So they have more flexibility at home.
So long as investors look at the economic fundamentals, they should treat different countries differently. There are many emerging markets that are perfectly able to sustain the level of debt they have, service this debt and continue to grow.
But sometimes markets are fickle. They ignore fundamentals and get caught up in self-fulfilling panics. And a speculative attack on a country, even with strong fundamentals, can be destabilised. So if I were an emerging markets finance minister, even one who had done everything right up until now, I would not rest easy at night.
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