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Inflation is always somebody else’s fault. Ludwig von Mises called out finger pointing central bankers and politicians decades ago in his book, Economic Policy. “The most important thing to remember is that inflation is not an act of God, that inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy.”
In the fall of 2007, Gideon Gono blamed his country’s inflation rate of 4,500 percent on “the differences that Zimbabwe has had with its former colonial master, the UK,” and added, “we are busy laying the foundations for a serious deceleration programme.” Deceleration? A year later inflation was 231 million percent.
Money printing didn’t have anything to do with it according to the central banker. Droughts began to be more frequent in the 2000’s and Gono believed ”there is a positive correlation between the drought and inflation.” Dry weather, he told New African magazine, has, “got a serious bearing on our inflation level.”
In Gono’s dilluded mind,inflation was about the weather, lack of support from other nations, and political sanctions. He had nothing to do with the hyperinflation in his country. “No other [central-bank] governor has had to deal with the kind of inflation levels that I deal with,” Gono told Newsweek. “[The people at] my bank [are] at the cutting edge of the country.”
These days in Argentina its not the weather and political sanctions causing prices to rise, its businesses engaging in commerce. President Cristina Fernández de Kirchner is urging her people to work “elbow-to-elbow” with her government to stop companies from looting the people with high prices. Two weeks ago the government devalued the peso by 20 percent but it is private businesses that are stealing from working people with price increases.
Posters of retail executives have been plastered around Buenos Aires. For instance, Wal-Mart Argentina’s president Horacio Barbeito has his mug on a poster with the caption, “Get to know them, these are the people who steal your salary.”
Kirchner’s cabinet chief Jorge Capitanich calls economists who point to government policies as inflation’s culprit “undercover agents.” He implies that these economists are the tools of business. “Argentines should know that independent, objective economists don’t exist,” Capitanich claims. “I want to say emphatically that when unscrupulous businessmen raise prices it has absolutely nothing to do with macroeconomic variables.”
In 2012 the president of Argentina’s central bank, Yale-educated Mercedes Marcó del Pont, said in an interview, “it is totally false to say that printing more money generates inflation, price increases are generated by other phenomena like supply and external sector’s behaviour.”
So while its central bank prints, the Kirchner government has enlisted the citizenry to work undercover in the fight against rising prices. A free smartphone application is encouraging Argentines to be citizen-cops while they shop.
The app is a bigger hit than “Candy Crush” and “Instagram.” President Kirchner wants “people to feel empowered when they shop.” And, they do. “You can go checking the prices,” marveled Analia Becherini, who learned of the app on Twitter. “You don’t even have to make any phone calls. If you want to file a complaint, you can do it online, in real time.”
“Argentina’s government blames escalating inflation on speculators and greedy businesses,” reports Paul Byrne for the Associated Press, “and has pressured leading supermarket chains to keep selling more than 80 key products at fixed prices.”
However, businesses aren’t eager to lose money selling goods. Fernando Aguirre told Chris Martenson that with price inflation running rampant, “Lots of stores don’t want to be selling stuff until they get updated prices. Suppliers holding on, waiting to see how things go, which is something that we are familiar with because that happened back in 2001 when everything went down as we know it did.”
In his Peak Prosperity podcast with Aguirre, Martenson makes the ironic point that when governments print excessive amounts of money, goods disappear from store shelves. In a hyper-inflation the demand for money drops to zero as people buy whatever they can get their hands on. Inflation destroys the calculus of profit and loss, destroying business, and undoing the division of labor.
Aguirre reinforced Martenson’s point. Describing shelves as “halfway empty,” in Argentina he said, “The government is always trying to muscle its way through these kind of problems, just trying to force companies to stock back products and such, but they just keep holding on. For example, gas has gone up 12% these last few days. And there is really nothing they can do about it. If they don’t increase prices, companies just are not willing to sell. It is a pretty tricky situation to be in.”
Tricky indeed. “It would be a serious blunder to neglect the fact that inflation also generates forces which tend toward capital consumption,” Mises wrote in Human Action. “One of its consequences is that it falsifies economic calculation and accounting. It produces the phenomenon of illusory or apparent profits.”
Inflation is also rampant at the other end of South America. Venezuela inflations is clocking in at 56 percent. Comparing the two countries, Leonardo Vera, a Caracas-based economist told the FT, “Argentina still has some ammunition to fight the current situation, while Venezuela is running out of bullets.”
Fast money growth has also led to shortages such as “newsprint to car parts and ceremonial wine to celebrate mass,” reports the FT.
Venezuelan president Nicolás Maduro is using the government’s heavy hand to introduce a law capping company profits at 30 percent. Heavy prison sentences await anyone found hoarding, overcharging, or “destabilising the economy.” Hundreds of inspectors have been deployed to enforce the mandates.
The results will be predictable. “With every new control, the parallel, or black market, dollar will keep going up, and so will the price and scarcity of milk, oil, and toilet paper,” says Humberto García, an economist with the Central University of Venezuela.
Don’t expect the printing to stop any time soon. Central bankers believe they are doing God’s work. “To ensure that my people survive, I had to print money,” Gideon Gono toldNewsweek. “I found myself doing extraordinary things that aren’t in the textbooks. Then the IMF asked the U.S. to please print money. The whole world is now practicing what they have been saying I should not. I decided that God had been on my side and had come to vindicate me.”
It seems disasters wrought by inflationary policies must be experienced again and again, as “Inflation is the true opium of the people,” Mises explained, “administered to them by anticapitalist governments.”
The practice of central banking is the same around the world. The only difference is in degree. Before he destroyed the Zimbabwean dollar Gono looked to America for inspiration. “Look at the bridges across the many rivers in New York and elsewhere,” Gono told New African, “and the other infrastructure in the country that were built with high budget deficits.”
The Zimbabwe, Argentina, and Venezuela inflations may seem to be something that happens to somebody else. But Mr. Aguirre makes a point when asked about 2001, when banks in Argentina, after a bank holiday, converted dollar accounts into the same number of pesos. A massive theft.
“Those banks that did that are the same banks that are found all over the world,” Aguirre says. “They are not like strange South American, Argentinean banks–they are the same banks. If they are willing to steal from people in one place, don’t be surprised if they are willing to do it in other places as well.”
Douglas E. French is a Director of the Ludwig von Mises Institute of Canada. Additionally, he writes for Casey Research and is the author of three books; Early Speculative Bubbles and Increases in the Supply of Money, The Failure of Common Knowledge, and Walk Away: The Rise and Fall of the Home-Owenrship Myth. French is the former president of the Ludwig von Mises Institute in Auburn, Alabama.
Economic and Political Quagmires
We want to briefly take another look at the situation in four of the emerging market countries that have recently been the focus of considerable market upheaval. The countries concerned are Turkey, Venezuela, Argentina and South Africa. There are considerable differences between these countries. The only thing that unites them is a worrisome trend in their trade and/or current account balances and the recent massive swoon in their currencies as foreign investors have exited their markets (this in turn has pressured the prices of securities). There is currently an economic and political crisis in three of the four countries, with South Africa the sole exception.
However, even South Africa is feeling the heat from the fact that it has a large current account deficit and the ongoing exodus of foreign investors from emerging markets. However, the country is actually used to experiencing vast fluctuations in foreign investment flows in short time periods and has the potential to relatively quickly turn its balance of payments position around. Of the four countries in question, it seems to us to be the most flexible one in this respect.
Argentina and Venezuela
Argentina and Venezuela are special cases in that their trade resp. current account positions are actually comparatively stronger, but the economic policies pursued by their governments are so utterly harebrained and repressive that everybody tries to get their money out as quickly as possible. The immediate problem is that both countries are being drained of foreign exchange reserves at an accelerating clip, inter alia a result of trying to keep their exchange rates artificially high. This is actually quite astonishing considering their considerable latent export prowess.
Both countries have governments that steadfastly deny the existence of economic laws and apparently genuinely believe that their absurd repressive decrees can ‘fix’ their economies. The markets regard Argentina as the slightly greater credit risk, as it is still fighting the so-called ‘hold-outs’ from its 2001 default. However, Venezuela is lately catching up, in spite of its vast oil wealth. The two countries currently have the dubious distinction of being the nations with the highest probability of sovereign debt default in the world – not even the crisis-ridden Ukraine comes remotely close (see chart of CDS spreads further below for details).
We have recently discussed the deteriorating situation in Venezuela in some detail and a more in-depth update on Argentina is in the works. Let us just note here that Argentina (the government of which is incidentally the fiercest supporter of Venezuela’s president Maduro at the moment) seems to be where Venezuela was about a year or so ago. Both countries are on the same path of inflationism and growing economic and financial repression.
Argentina’s balance of trade remains positive – click to enlarge.
Venezuela is a big oil exporter, but needs to import 70% of the consumer goods sold in the country. Its balance of trade is therefore deeply negative, especially as the state-run (‘very, very red’) PDVSA is being run into the ground and produces less and less oil – click to enlarge.
In spite of reporting a positive current account balance, Venezuela is losing foreign exchange reserves fast, due to trying to maintain an artificially high exchange rate even in the face of soaring inflation – click to enlarge.
In Venezuela’s and Argentina’s case, the markets are rightly worried that the situation will probably deteriorate further. The intransigence of their governments with regard to pursuing economic policies that demonstrably don’t work and the resultant growing political risks conspire to create a highly unstable backdrop. As in all such cases, one must expect knock-on effects to emerge elsewhere.
Turkey has been hailed as a shining example of how an emerging economy should grow, but as is so often the case, it has in the meantime become evident that what it has mainly done was to engage in a massive credit-financed boom, displaying all the associated bubble activities, malinvestment of capital and overconsumption. This unsustainable boom was exacerbated by the fact that the Erdogan government pressured the central bank to keep rates extremely low. Even while prices were obviously misbehaving, with the rate of change of CPI oscillating between about 6.2% and nearly 11% and the stock market rising in parabolic fashion, the central bank kept its repo rate in the low single digits (this has only very recently changed).
With his country in the middle of a serious economic crisis, Erdogan has come under fire politically because his government has turned out to be a den of corruption to boot. So what does he do? He is taking a leaf from what the Western nations have demonstrated to be de rigeur these days, since don’t you know, we’re all surrounded by evil terrorists hiding in caves in the Hindu Kush somewhere. In short, he is moving toward increasingly authoritarian rule. Just take a look at this recent press report:
“Battling a corruption scandal, Turkish Prime Minister Tayyip Erdogan is seeking broader powers for his intelligence agency, including more scope for eavesdropping and legal immunity for its top agent, according to a draft law seen by Reuters.
The proposals submitted by Erdogan’s AK Party late on Wednesday are the latest in what his opponents see as an authoritarian backlash against the graft inquiry, after parliament passed laws tightening government control over the Internet and the courts this month.
The bill gives the National Intelligence Organisation (MIT) the authority to conduct operations abroad and tap pay phones and international calls. It also introduces jail terms of up to 12 years for the publication of leaked classified documents. It stipulates that only a top appeals court could try the head of the agency with the prime minister’s permission, and would require private companies as well as state institutions to hand over consumer data and technical equipment when requested.
“This bill will bring the MIT in line with the necessities of the era, grant it the capabilities of other intelligence agencies, and increase its methods and capacity for individual and technical intelligence,” the draft document said.
The ‘necessities of the era‘ – we couldn’t have put it in a more Orwellian fashion. And guess what? The vaunted ‘defenders of freedom’ in the West probably aren’t going to object for even a millisecond.
Turkey’s economy is a shambles right now, and Erdogan wants to cling to power by any means possible – that is what the ‘necessities of the era’ are really all about. For a long time it was held that the world as a whole was moving toward more, rather than less freedom. We regret to inform you that this trend has reversed more than a decade ago, on the day the WTC towers crumbled.
Meanwhile, what is now also crumbling is Turkey’s economy. However, we would argue that Turkey’s economic situation isn’t ‘unfixable’ if the proper policies are implemented quickly. After all, there has been a very successful period of economic liberalization under Erdogan’s government as well, which has left the economy more flexible and thus better able to deal with adverse developments. A wrenching adjustment is nevertheless unavoidable at this point.
Turkey has a large current account deficit. The fact that foreign investment inflows have now dried up is putting enormous strain on the economy. Consumer confidence has plunged, as has the currency – click to enlarge.
As one analyst sagely remarked:
“From 2009 to 2013, Turkey was considered by many to be a rising star among the emerging markets, but currently it may be the triggering force for worsening the emerging-market outlook globally in 2014.”
South Africa’s case is in many ways comparable to Turkey’s – the country also sports a large current account and trade deficit for example. However, while South Africa’s CPI ‘inflation’ rate has always been high by developed country standards, it has on average been much lower and less volatile than Turkey’s, fluctuating between 5% and 6.4% in recent years. Contrary to Turkey’s central bank, South Africa’s central bank is fiercely independent and focused solely on keeping CPI in check. In fact, it may well be one of the world’s most conservative central banks. It also refuses to intervene in the currency market and allows the Rand to go to wherever market forces push it. This non-intervention policy was actually quite difficult to defend while the Rand was among the world’s strongest currencies during the emerging markets boom of the 2000d’s. A plethora of special interests in South Africa were pleading with the central bank to do something to weaken the Rand, but it remained steadfast.
While the current account deficit means that more currency weakness is probably in store, South Africa does have a vibrant export sector. During the apartheid years, it had a perennial trade surplus, partly a result of being forced to conserve foreign exchange reserves in the face of economic sanctions. Similar to Turkey, South Africa imports all the oil it uses, which is a key vulnerability of both countries. However, the weakening of the Rand already has an effect: the trade balance has recently turned positive for the first time since 2010.
South Africa’s current account is still deeply in the red – click to enlarge.
However, a trade surplus has begun to emerge on the back of the weaker Rand – click to enlarge.
Investors in emerging markets like to use the Rand as a hedge for EM currency exposure, due to its relatively good liquidity and the fact that the central bank isn’t going to intervene directly. At times this fact probably exacerbates the moves in the Rand.
The political situation in South Africa is almost always somewhat dubious, and the Zuma presidency is no exception to that rule. There is a lot of corruption and quite a few economic policy decisions appear to us to be misguided. One must keep in mind in this context that the ANC government is continually under pressure to deliver an improvement in living standards to the formerly oppressed parts of the population, which often leads to the adoption of populist positions that are not economically sensible.
However, there exist also many misconceptions about SA and the ANC’s political legacy in the West. In spite of being formally allied with the communists (SACP) and the trade union umbrella body COSATU, the ANC has for instance privatized many of the companies that used to be state-owned under the national-socialist regime of the National Party (NP) that ruled the country during the apartheid years (a funny aside to this: the NP has dissolved itself and has been amalgamated with the ANC a few years ago). One slightly worrisome development is that the government deficit has grown sharply since 2010. While the government previously ran an almost balanced budget, the annual deficit amounted to more than 5% of GDP over the past four years. Nevertheless, due to the tight fiscal policy implemented previously, the public debt-GDP ratio is still below 40% – a number most developed countries can only dream of.
Sovereign Credit Risk
As can be seen above, the markets consider Turkey the second-smallest sovereign credit risk among the four nations at the moment. Its debt-to-GDP ratio is very similar to South Africa’s, at just 36%. The budget deficit has fluctuated between 2.8% and 5.5% of GDP over the past four years. Both data points are however what we would term ‘remnants of the bubble’, as the government’s tax revenues soared along with the economic boom. With the boom faltering, a sharp deterioration in these data points should be expected.
South Africa is actually in a slightly better position in this regard, as it has not experienced comparable boom conditions. Consequently the fact that the CDS spread on its sovereign debt is actually slightly below that of Turkey makes sense.
Argentina is currently considered the worst sovereign credit risk in the world – not least due to the fact that its foreign exchange reserves have declined dramatically and the trend is ongoing.
This throws more and more doubt on the country’s ability to service its foreign debt, which in the light of the 2001 default and its aftermath has made the markets wary. 5 year CDS spreads at 2,206 basis points reflect a great deal of risk (this represents an annual default probability of roughly 17% at an assumed 40% recovery rate).
Venezuela is lately catching up – its 5 year sovereign CDS spreads have soared to almost 1,700 basis points from less than 1,200 at the end of last year. This is testament to the fact that the economy has begun to implode under the Maduro government. While Maduro himself is just as bad as Chavez was in terms of economic policy, it should be pointed out that Chavez’ policies are what laid the foundations for current events. It has taken a while for this South America-style goulash-socialism to fail, as it allowed a remnant of the market economy to operate most of the time. However, the impositions on the private sector have simply become too onerous and galloping inflation has delivered the coup de grace, as economic calculation has become extremely distorted, if not nigh impossible.
The crisis in emerging market economies vulnerable to capital flight is unlikely to be over. Note that we have picked merely four cases, but there are several other developing countries that are currently in various states of political and economic crisis as well (e.g. India, Thailand, Brazil, to name a few). We have looked the two worst cases here, one of medium severity (Turkey) and one of the better cases (South Africa) in order to present as broad an overview as possible. The fate of Argentina and Venezuela is up in the air – it will require massive political change to alter their prospects.
However, other emerging market economies are bound to eventually bounce back and exhibit strong economic growth again. The imbalances can all be overcome, but the adjustments required are liable to play out in the form of economic and financial market crises of varying severity.
One must not forget in this context that Japan continues to pursue a mercantilist currency policy, which redounds on its competitors in Asia, which in turn affects their main suppliers. We continue to believe that Japan’s decision to weaken the yen has been a major contributor to recent currency turmoil elsewhere (of course, this does not mean that many of the countries concerned have not been wanting in terms of their own policies).
Moreover, China is hanging over the proceedings like the proverbial Sword of Damocles. HSBC has just reported its latest flash estimate on China’s manufacturing PMI (pdf), which was quite weak at 48.3, a seven month low indicating a worsening contraction. In view of the enormous credit bubble which China has embarked on since 2008 (about $15 trillion in additional debt have been created since then), the danger of a larger setback being set in motion by a sharp slowdown or even recession in China cannot be dismissed.
Charts by: Tradingeconomics, Reuters, Bloomberg
While Europe, and the bulk of the Developed World is struggling to dig out of its unprecedented credit crunch (in which central banks are the only source of credit money which instead of entering the economy is stuck in the capital markets via the reserve pathway) and resulting deflation, the rest of the Emerging Market world is doing just fine. If by fine one means inflation at what Goldman calls, bordering on “extreme levels.” This is shown in the chart below which breaks down the Y/Y change in broad prices across the main DM and EM countries, and which shows that when talking about inflation there are two worlds: the Emerging, where inflation is scorching, and Developing, where inflation is in a state of deep freeze.
What is notable here is that despite hopes for a convergence between the inflationary trends in the Developed (downside extremes) and Emerging (upside extremes) world for the past year, what has happened instead is an acceleration of the process especially in recent weeks as EMs have been forced to devalue their currencies at an ever faster pace in order to offset the impact of the taper, leading to surging inflation as Turkey, Argentina, and Venezuela among many others, have found out the hard way in just the past month.
And as inflation in EM nations continues to roil ever higher not only does the implicit exporting of deflation to the DM accelerate, but it means that their societies approach ever closert to the tipping point when the citizens decide they have had just about enough with their government and/or their currency and decide to change one and/or the other. Hopefully, in a peaceful matter.
Submitted by Adam Taggart of Peak Prosperity,
Argentina is a country re-entering crisis territory it knows too well. The country has defaulted on its sovereign debt three times in the past 32 years and looks poised to do so again soon.
Its currency, the peso, devalued by more than 20% in January alone. Inflation is currently running at 25%. Argentina’s budget deficit is exploding, and, based on credit default swap rates, the market is placing an 85% chance of a sovereign default within the next five years.
Want to know what it’s like living through a currency collapse? Argentina is providing us with a real-time window.
So, we’ve invited Fernando “FerFAL” Aguirre back onto the program to provide commentary on the events on the ground there. What is life like right now for the average Argentinian?
Aguirre began blogging during the hyperinflationary destruction of Argentina’s economy in 2001 and has since dedicated his professional career to educating the public about his experiences and observations of its lingering aftermath. He is the author of Surviving the Economic Collapse and sees many parallels between the path that led to Argentina’s decline and the similar one most countries in the West, including the U.S., are currently on. Our 2011 interview with him “A Case Study in How An Economy Collapses” remains one of Peak Prosperity’s most well-regarded.
Chris Martenson: Okay. Bring us up to date. What is happening in Argentina right now with respect to its currency, the peso?
Fernando Aguirre: Well, actually pretty recently, January 22, the peso lost 15% of its value. It has devalued quite a bit. It ended up losing 20% of its value that week, and it has been pretty crazy since then. Inflation has been rampant in some sectors, going up to 100% in food, grocery stores 20%, 30% in some cases. So it has been pretty complicated. Lots of stores don’t want to be selling stuff until they get updated prices. Suppliers holding on, waiting to see how things go, which is something that we are familiar with because that happened back in 2001 when everything went down as we know it did.
Chris Martenson: So 100%, 20% inflation; are those yearly numbers?
Fernando Aguirre: Those are our numbers in a matter of days. In just one day, for example, cement in Balcarce, one of the towns in Southern Argentina, went up 100% overnight, doubling in price. Grocery stores in Córdoba, even in Buenos Aires, people are talking about increase of prices of 20, 30% just these days. I actually have family in Argentina that are telling me that they go to a hardware store and they aren’t even able to buy stuff from there because stores want to hold on and see how prices unfold in the following days.
Chris Martenson: Right. So this is one of those great mysteries of inflation. It is obviously ‘flying money’, so everyone is trying to get rid of their money. You would think that would actually increase commerce. But if you are on the other end of that transaction, if you happen to be the business owner, you have every incentive to withhold items for as long as possible. So one of the great ironies, I guess, is that even though money is flying around like crazy, goods start to disappear from the shelves. Is that what you are seeing?
Fernando Aguirre: Absolutely. Shelves halfway empty. The government is always trying to muscle its way through these kind of problems, just trying to force companies to stock back products and such, but they just keep holding on. For example, gas has gone up 12% these last few days. And there is really nothing they can do about it. If they don’t increase prices, companies just are not willing to sell. It is a pretty tricky situation to be in.
Chris Martenson: Are there any sort of price controls going on right now? Has anything been mandated?
Fernando Aguirre: As you know, price controls don’t really work. I mean, they tried this before in Argentina. Actually, last year one of the big news stories was that the government was freezing prices on food and certain appliances. It didn’t work. Just a few days later those supposedly “frozen” prices were going up. As soon as they officially released them, they would just double in price.
Chris Martenson: Let me ask you this, then: How many people in Argentina actually still have money in Argentine banks in dollars? One of the features in 2001 was that people had money in dollars, in the banks. There was a banking holiday; a couple of weeks later, banks open up; Surprise, you have the same number in your account, only it’s pesos, not dollars. It was an effective theft, if I could use that term. Is anybody keeping money in the banks at this point, or how is that working?
Fernando Aguirre: Well, first of all, I would like to clarify for people listening: Those banks that did that are the same banks that are found all over the world. They are not like strange South American, Argentinean banks – they are the same banks. If they are willing to steal from people in one place, don’t be surprised if they are willing to do it in other places as well.
Click the play button below to listen to Chris’ interview with Fernando Aguirre (36m:42s):
It has gone from being one of the world’s wealthiest nations to a serial defaulter, but can it get back on track?
Counting the Cost Last updated: 08 Feb 2014 04:56
|Argentina was once the world’s seventh richest country. But economic mismanagement by successive governments has left the country looking down the barrel of another default.
Since the 1980s, Buenos Aires has defaulted three times on its debts – most famously, perhaps, in 2001 when it refused to pay the creditors of its $95bn debt. Since then it has essentially been shut out of international markets.
To service its debt, Argentina started using central bank reserves. But the peso has been devalued by almost 20 percent, leading to spiralling inflation as a toxic cocktail of uncertainty and speculation drives prices through the roof. And Argentinians are feeling the pinch:
“We are in bad shape,” says mother of six Cynthia Cabrera. “With what my husband makes loading trucks at the vegetable market, we can’t survive. I have to ask the grocer to give us credit. We live day to day. Here we either eat at midday or at night; I can’t afford two meals now.”
So, what will it take for the government to get the country’s economy back on track? And can it come soon enough?
A double-edged economic sword
When a central bank raises interest rates, it increases the value of its currency, curbing inflation, cooling the economy and attracting investors seeking higher returns.
Lowering interest rates, on the other hand, devalues a currency, making it less attractive to investors, but easier for businesses and consumers to borrow money and spur economic growth.
Some forces, however, are beyond the control of central bankers, especially those presiding over emerging economies vulnerable to sudden shifts in foreign investment. Political unrest or disappointing economic news at home or in key trading partners can trigger a flight of capital from emerging markets.
For six years, the Federal Reserve’s low interest rate policies have pushed investors into emerging markets such as Turkey, Brazil, Argentina and South Africa where they could earn more for their money.
Many have profited handsomely from fast-growing industries feeding China’s insatiable demand for raw materials, but a slowdown in China’s manufacturing combined with Fed stimulus unwinding has spooked emerging markets investors. In recent weeks, they have cashed in their chips for dollars, leaving a glut of devalued local currencies and while that makes exports more attractive, it also raises the frightening spectre of runaway inflation.
Counting the Cost examines this double-edged economic sword.
Europe’s lost generation?
Unemployment is the millstone of this financial crisis, and particularly so amongst 15 to 24 years old. About one-in-four young people in the European Union are unemployed. In the US it is only slightly better at 16 percent.
In the UK alone, youth unemployment cost almost $8bn in 2012, and according to consultancy firm McKinsey, 27 percent of employers have left ‘entry level’ jobs unfilled because they could not find anyone with the necessary skills.
So, how can youth unemployment be tackled? And has it created a lost generation?
While we are sure it is a very sad coincidence, on the day when Argentina decrees limits on the FX positions banks can hold and the Argentine Central Bank’s reserves accounting is questioned publically, a massive fire – killing 9 people – has destroyed a warehouse archiving banking system documents. As The Washington Post reports, the fire at the Iron Mountain warehouse (which purportedly had multiple protections against fire, including advanced systems that can detect and quench flames without damaging important documents) took hours to control and the sprawling building appeared to be ruined. The cause of the fire wasn’t immediately clear – though we suggest smelling Fernandez’ hands…
While first print is preliminary and subject to revision, the size of recent discrepancies have no precedent. This suggest that the government may be attempting to manage expectations by temporarily fudging the “estimate ” of reserve numbers (first print) while not compromising “actual” final reported numbers. If this is so, it is a dangerous game to play and one likely to back-fire.
During a balance of payments crisis – as Argentina is undergoing – such manipulation of official statistics (and one so critical for market sentiment) is detrimental to the needed confidence building around the transition in the FX regime.
And today the government decrees limits on FX holdings for the banks…
Argentina’s central bank published resolution late yday on website limiting fx position for banks to 30% of assets.
Banks will have to limit fx futures contracts to 10% of assets: resolution
Banks must comply with resolution by April 30
And then this happens…
Nine first-responders were killed, seven others injured and two were missing as they battled a fire of unknown origin that destroyed an archive of bank documents in Argentina’s capital on Wednesday.
The fire at the Iron Mountain warehouse took hours to control…
The destroyed archives included documents stored for Argentina’s banking industry, said Buenos Aires security minister Guillermo Montenegro.
The cause of the fire wasn’t immediately clear.
Boston-based Iron Mountain manages, stores and protects information for more than 156,000 companies and organizations in 36 countries. Its Argentina subsidiary advertises that itsfacilities have multiple protections against fire, including advanced systems that can detect and quench flames without damaging important documents.
“There are cameras in the area, and these videos will be added to the judicial investigation, to clear up the motive of the fire and collapse,” Montenegro told the Diarios y Noticias agency.
A few days ago, in the aftermath of Argentina’s shocking devaluation announcement, we showed the one most important chart for the future of that country’s economy: the correlation between the value of the Arg Peso and the amount of Central Bank foreign reserves, both crashing. And as we predicted when we, before anyone else, started our countdown of Argentina’s reserves, once the number hits zero it’s game over for the Latin American country. Or rather, game over again, considering the number of times in the past Argentina has defaulted. Unfortunately over the past week, things for the Central Bank have gone from bad to worse and were capped overnight with the following headline:
- ARGENTINE CENTRAL BANK SAYS RESERVES FELL $170M TO 28.1B TODAY
To summarize: Argentina has now burned through $2 billion in less than two weeks, the fastest outflow since 2006, and a trend which if sustained (and we see no reason why it would change), means it has just over half a year left of reserves projecting a linear decline. However, since the lower the amount of reserves, the faster the withdrawals will come, it is safe to predict that the endgame for Argentina will come far sooner, just as its suddenly crashing bonds seem to have realized.
Which is perhaps why, as Argentina’s La Nacion reports, the country is suddenly, and long overdue, scrambling to raise $10 billion to “counter the flight of capital” from the country.
Alas, it just may be too late.
According to the website, Argentina’s economy minister Axel Kicillof secretly approached international banks, the same one he has been criticizing over the past months, with a simple request: please give me $10 billion. Alas, considering the country’s track record of “honoring” its debt repayment promises, not even promising the required interest rate of +? will do much to generate interest in this particular offer banks can not refuse. Or, rather, can and will.
From La Nacion, Google translated:
Nacion reporters say that the meeting was held in strictest confidence, just in the days before major upheaval in the exchange market. When asked about it, the Economy Ministry spokesman did not confirm nor denied the information, in ABA did not respond to calls from this newspaper.
It is imperative for Argentina to get the dollars that can counter the flight of capital, which in January alone cost the Central Bank (BCRA) U.S. $ 2.499 billion of its reserves. It was the biggest drop since 2006, when the country repaid its entire debt of more than U.S. $ 9 billion to the International Monetary Fund (IMF).
The minister confided bankers requesting leave to look for dollars abroad, either by issuing new debt or through commercial credit lines that banks could get. Some entities, according to sources consulted by the NATION, and would have set to work to organize a tour to Kicillof investment to New York this month.
In other words, Argentina will be meeting Goldman shortly. So, in the aftermath of the Denmark Dong affair, we can probably expect another government “overhaul” in a few months, mediated by everyone’s favorite vampire squid who is about to make Argentina an offer it can’t refuse. Or maybe even Goldman won’t touch this any more:
The order of Kicillof, noted the sources, was debated this week between ABA bankers. Although they pledged to work in private they also recognized that it will be difficult in the current context for Argentina to access fresh funding at a reasonable rate of interest and, especially, in the amounts the Government needs, somewhere around U.S. $ 10,000 million.
It gets worse:
In addition, they assert, although the Government intends to solve their conflicts with the Paris Club and Repsol, the devaluation of 18.6% recorded in January, the highest in the last 12 years,quite complicated negotiations, and that sowed new doubts about the ability to repay debt Argentina.
Yes, well, losing 20% of your investment “gains” overnight due to an arbitrary decision by the government does kinda make one want to invest in said government for a bit to quite a bit. As for the inflationary panic that has already gripped the country, and which we already commented on, well – it’s only just begun.
Still, all of the above is largely expected, and was perfectly predictable by anyone not caught up in overconsumption of hopium pills, or having their head stuck in the sand of denial. The one thing wedid learn is something which will soon make the front pages of all serious media publications around the globe.
After sharp declines in recent weeks, a sovereign dollar bond Bonar 17 yielded 16.2% yesterday…. Several weeks ago Kicillof announced his intentions to return to the debt markets. The National Social Security Administration (Anses) began in early January to sell their bonds in the market Bonar 18 to contain the escalation of the “dollar bag” on one hand, but also to begin to make a curve in the medium term rates.
Curious what the BONAR is? Courtesy of this handy glossary of Argentine financial terms and acronyms, we now know that it is the formal name of an Argentina dollar-denominated bond issued under domestic law. Or, as in the case of Greece, precisely the instrument that will quite soon be crammed down due to non-existent covenant protection for creditors.
In other words, in a worst case for Argentina scenario, watch as hundreds of millions of BONARs suddenly deflate to nothing in a bidless market.
Some very relevant observations from Louis Gave of Evergreen GaveKal
Who Will The Emerging Markets Crisis Adjust Against?
In last summer’s emerging market sell-off, India was very much at the center of the storm: the rupee collapsed, bond yields soared and equity markets tanked. The Reserve Bank of India responded by raising rates while the government introduced harsh restrictions on gold imports. Promptly, the Indian current account deficit shrank. So much so that, in the current emerging market (EM) meltdown, India has been spared relative to most other current account deficit emerging markets, whether Turkey, Brazil, South Africa or Argentina. And on this note, the inability of the Turkish lira, South African rand, Brazilian real, etc. to hold on to gains after recent hawkish moves by their central banks is problematic. Markets won’t be calmed until there is clear evidence these countries’ current account deficits can improve. But how can these adjustments happen?
The problem is twofold. First, current accounts are a zero sum game, so future improvements in emerging market trade balances have to come at someone else’s expense. Second, we have had, over the past year, only modest growth in global trade; so if EM balances are to improve markedly, somebody’s will have to deteriorate.
When the 1994-95 “tequila crisis” struck, the US current account deficit widened to allow for Mexico to adjust. The same thing happened in 1997 with the Asian crisis, in 2001 when Argentina blew, and in 2003 when SARS crippled Asia. In 1998, oil prices took the brunt of the adjustment as Russia hit the skids. In 2009-10, it was China’s turn to step up to the plate, with a stimulus-spurred import binge that meaningfully reduced its current account surplus.
Which brings us to today and the question of who will adjust their growth lower (through a deterioration in their trade balances) to make some room for Argentina, Brazil, Turkey, South Africa, Indonesia…? There are really five candidates:
- China, again? That seems unlikely. Instead, China’s policymakers continue to do all they can to deleverage, despite the cost of a slowing economic expansion. Moreover, mercantilism still rides high in the corridors of power in Beijing and so the willingness to move to a current account deficit is simply not there.
- The US, again? As discussed in our recent book (see Too Different For Comfort), the Federal Reserve’s attitude since the global financial crisis has consistently been one of: “the US dollar is our currency and your problem.” The Fed has been happy to print and devalue the US dollar, leaving other countries to deal with the consequences. The days of the US acting as the backstop in the system are now behind us.
- Oil: In the past, collapsing oil prices have come to the rescue during emerging market crises. Of course, this accentuates problems for the EMs dependent on high energy prices for their growth, but is a boon for others (including India, China, Korea, Turkey). Unfortunately, for now, energy prices are not falling, with some more localized markets, like US natural gas, seeing a surge amid record cold snaps.
- Japan: Japan, which has been such a non-player for twenty years, is once again finding its feet. However, it is doing so by exporting its deflation through a central bank orchestrated currency devaluation. How this “beggar-thy-neighbor policy” will help the struggling emerging markets is hard to see, except perhaps through a) capital flows from rich Japanese savers into by now higher yielding EM debt, or b) import substitution on the part of threatened emerging markets where the end consumers will perhaps replace high priced US dollar/euro denominated imports of manufactured goods for cheaper yen denominated ones?
- Euroland: The currency zone’s slight trade surplus is largely due to Germany. However, Germany’s exports to Turkey, Russia, Brazil, etc., will likely suffer as domestic demand implodes in these countries. In this sense—the euroland will be the likeliest candidate on the other side of the EM current account adjustment. Unfortunately, odds are this will take place through falling European exports rather than rising European imports and/or rising EM exports to the eurozone. This is not a good harbinger for global growth.
In short, either oil collapses very soon, or the US dollar shoots up (with Janet Yellen about to take the helm, is that likely?) or we could soon be facing a contraction in global trade. And unfortunately, contractions in global trade are usually accompanied by global recessions. With this in mind, and as we argued in Eight Questions For 2014, maintaining positions in long-dated OECD government bonds as hedges against the unfolding of a global deflationary spiral (triggered by the weak yen, a slowing China, busting emerging markets and an uninspiring Europe…) makes ample sense.
Global stocks were hammered on Friday for a second straight day on news of a slowdown in China and turbulence in emerging markets. The Dow Jones Industrials suffered its worse drubbing in more than two years, tumbling 318 points on Friday to end a 490 point two-day rout. Emerging markets currencies were whipsawed by capital flight as foreign investors fled to the safety of U.S. Treasuries. Turkey’s lira and the Argentine peso were particularly hard hit setting record lows in the 48 hour period. The scaling back of the Fed’s $85 billion per month asset purchase program, called QE, has altered the dynamic that made emerging markets the “engines for global growth”. The policy reversal has triggered a selloff in risk assets and sent EM currencies plunging. Here’s a summary from Bloomberg:
“The worst selloff in emerging-market currencies in five years is beginning to reveal the extent of the fallout from the Federal Reserve’s tapering of monetary stimulus, compounded by political and financial instability.
Investors are losing confidence in some of the biggest developing nations, extending the currency-market rout triggered last year when the Fed first signaled it would scale back stimulus. While Brazil, Russia, India, China and South Africa were the engines of global growth following the financial crisis in 2008, emerging markets now pose a threat to world financial stability.” (“Contagion Spreads in Emerging Markets as Crises Grow,” Bloomberg)
Paradoxically, Bloomberg editors blame the victims of the Fed’s failed policy for the current ructions in the markets. In an article titled, “What’s Behind the Emerging-Market Meltdown” the editors say,”emerging-market governments … should recognize that this week’s financial-market turmoil was, to varying degrees, their own fault.” … “the best way for emerging-market governments to restore confidence would be to improve their policies.”
Logically, one would assume that the editors would throw their support behind capital controls or other means of stemming the destructive flow of speculative capital into domestic markets. But that’s not the case. What the editors really want, is policies that trim deficits, slash public spending, and allow foreign investors to continue to wreak havoc on vulnerable economies that follow their free market diktats. The article is a defense of the status quo, of maintaining the same ruinous policies so that profit-taking can continue apace.
The Fed was warned early on that its uber-accommodative monetary policy was spilling over into emerging markets and creating conditions for another financial crisis. Take a look at this excerpt from an article in Bloomberg back in 2010 where Nobel prize winning economist, Joseph Stiglitz, explicitly warns the Fed of the dangers of QE.
“The U.S. Federal Reserve’s plan to boost purchases of bonds poses “considerable” risks by increasing capital inflows to emerging markets, Nobel Prize- winning economist Joseph Stiglitz said in Santiago today.
“All this liquidity that they’re creating is not going back to grow the American economy and is going to Asia and other emerging markets where it’s not wanted,” Stiglitz said…..Increased capital inflows could cause emerging market currencies to appreciate and could create asset bubbles, he said.” (“Stiglitz Says Fed Stimulus Poses `Considerable’ Risks for Emerging Markets,” Bloomberg, Dec 2010)
Events have unfolded exactly as Stiglitz predicted they would, which means the Fed is 100% responsible the carnage in the stock and currencies markets.
The policy has pumped nearly “$7 trillion of foreign funds” into EMs since QE was first launched in 2009. According to the Telegraph’s Ambrose Evans-Pritchard, “much of it “hot money” going into bonds, equities and liquid instruments that can be sold quickly….Officials are concerned that this footloose capital could leave fast in a crisis, setting off a cascade effect,” Pritchard adds ominously.
Whether last week’s bloodbath was just a prelude to a bigger crash is impossible to say, but it is worth noting that the Fed has only reduced its purchases by a mere $10 billion per month while still providing $75 billion every 30 days. That suggests that markets will probably face greater turmoil in the months ahead. Check out this clip from USA Today:
“Emerging markets need the hot money but capital is exiting now,” says (Blackrock’s Russ) Koesterich. “What you have is people saying, ‘I don’t want to own emerging markets.’…
The bigger fear is if the current crisis in currency markets morphs into a full-blown economic crisis and leads to financial contagion, says Matthias Kuhlmey, managing director of HighTower’s Global Investment Solutions.
“The currency story is fascinating and can be a slippery slope – be cautious,” says Kuhlmey, adding that the Asian crisis in the summer of 1997 that started with a sharp drop in the value of Thailand’s baht, turned into a broader economic crisis that engulfed Indonesian, South Korea and a handful of other countries. It also rocked financial markets.” (“Why emerging markets worry Wall Street,” USA Today)
So, is this the Big One, the beginning of the next financial crisis?
It’s too early to say, but investors and analysts are worried. Fed tightening (via “taper”) will be felt in markets around the world. The trouble in emerging markets will intensify deflationary pressures in the Eurozone and put a damper on China’s growth. Slower global growth, in turn, will create balance sheets problems for undercapitalized and over-leveraged banks and other financial institutions which will increase the probability of another Lehman Brothers-type default.
According to Reuters, a normalizing of interest rates in the US, (which most analysts expect) “could cut financial inflows to developing countries by as much as 80 percent for several months. In such a case, nearly a quarter of developing countries could experience sudden stops in their access to global capital, throwing some economies into a balance of payments or financial crisis, the Bank said.” (“Rout in emerging markets may only be in Phase One,” Reuters)
Clearly, the potential for another financial meltdown is quite real.
For more than four years, the Fed has buoyed stock prices and increased corporate margins through massive injections of free cash into the financial markets. Now the Central Bank wants to change the policy and ease its foot off the gas pedal. That’s causing investors to rethink their positions and take more money off the table. What started as a selloff in emerging markets could snowball into a broader panic that could wipe out the gains of the last four years.
The Federal Reserve is entirely responsible for this new wave of financial instability.
Mike Whitney lives in Washington state. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion (AK Press). Hopeless is also available in a Kindle edition. He can be reached at email@example.com.
This time, the Federal Reserve has created a truly global problem. A big chunk of the trillions of dollars that it pumped into the financial system over the past several years has flowed into emerging markets. But now that the Fed has decided to begin “the taper”, investors see it as a sign to pull the “hot money” out of emerging markets as rapidly as possible. This is causing currencies to collapse and interest rates to soar all over the planet. Argentina, Turkey, South Africa, Ukraine, Chile, Indonesia, Venezuela, India, Brazil, Taiwan and Malaysia are just some of the emerging markets that have been hit hard so far. In fact, last week emerging market currencies experienced the biggest decline that we have seen since the financial crisis of 2008. And all of this chaos in emerging markets is seriously spooking Wall Street as well. The Dow has fallen nearly 500 points over the last two trading sessions alone. If the Federal Reserve opts to taper even more in the coming days, this currency crisis could rapidly turn into a complete and total currency collapse.
A lot of Americans have always assumed that the U.S. dollar would be the first currency to collapse when the next great financial crisis happens. But actually, right now just the opposite is happening and it is causing chaos all over the planet.
For instance, just check out what is happening in Turkey according to a recent report in the New York Times…
Turkey’s currency fell to a record low against the dollar on Friday, a drop that will hit the purchasing power of everyone in the country.
On a street corner in Istanbul, Yilmaz Gok, 51, said, “I’m a retiree making ends meet on a small pension and all I care about is a possible increase in prices.”
“I will need to cut further,” he said. “Maybe I should use my natural gas heater less.”
As inflation escalates and interest rates soar in these countries, ordinary citizens are going to feel the squeeze. Just having enough money to purchase the basics is going to become more difficult.
And this is not just limited to a few countries. What we are watching right now is truly a global phenomenon…
“You’ve had a massive selloff in these emerging-market currencies,” Nick Xanders, a London-based equity strategist at BTIG Ltd., said by telephone. “Ruble, rupee, real, rand: they’ve all fallen and the main cause has been tapering. A lot of companies that have benefited from emerging-markets growth are now seeing it go the other way.”
So why is this happening? Well, there are a number of factors involved of course. However, as with so many of our other problems, the actions of the Federal Reserve are at the very heart of this crisis. A recent USA Today article described how the Fed helped create this massive bubble in the emerging markets…
Emerging markets are the future growth engine of the global economy and an important source of profits for U.S. companies. These developing economies were both recipients and beneficiaries of massive cash inflows the past few years as investors sought out bigger returns fostered by injections of cheap cash from the Federal Reserve and other central bankers.
But now that the Fed has started to dial back its stimulus, many investors are yanking their cash out of emerging markets and bringing the cash back to more stable markets and economies, such as the U.S., hurting the developing nations in the process, explains Russ Koesterich, chief investment strategist at BlackRock.
“Emerging markets need the hot money but capital is exiting now,” says Koesterich. “What you have is people saying, ‘I don’t want to own emerging markets.'”
What we are potentially facing is the bursting of a financial bubble on a global scale. Just check out what Egon von Greyerz, the founder of Matterhorn Asset Management in Switzerland, recently had to say…
If you take the Turkish lira, that plunged to new lows this week, and the Russian ruble is at the lowest level in 5 years. In South Africa, the rand is at the weakest since 2008. The currencies are also weak in Brazil and Mexico. But there are many other countries whose situation is extremely dire, like India, Indonesia, Hungary, Poland, the Ukraine, and Venezuela.
I’m mentioning these countries individually just to stress that this situation is extremely serious. It is also on a massive scale. In virtually all of these countries currencies are plunging and so are bonds, which is leading to much higher interest rates. And the cost of credit-default swaps in these countries is surging due to the increased credit risks.
And many smaller nations are being deeply affected already as well.
For example, most Americans cannot even find Liberia on a map, but right now the actions of our Federal Reserve have pushed the currency of that small nation to the verge of collapse…
Liberia’s finance minister warned against panic today after being summoned to parliament to explain a crash in the value of Liberia’s currency against the US dollar.
“Let’s be careful about what we say about the economy. Inflation, ladies and gentlemen, is not out of control,” Amara Konneh told lawmakers, while adding that the government was “concerned” about the trend.
Closer to home, the Mexican peso tumbled quite a bit last week and is now beginning to show significant weakness. If Mexico experiences a currency collapse, that would be a huge blow to the U.S. economy.
Like I said, this is something that is happening on a global scale.
If this continues, we will eventually see looting, violence, blackouts, shortages of basic supplies, and runs on the banks in emerging markets all over the planet just like we are already witnessing in Argentina and Venezuela.
Hopefully something can be done to stop this from happening. But once a bubble starts to burst, it is really difficult to try to hold it together.
Meanwhile, I find it to be very “interesting” that last week we witnessed the largest withdrawal from JPMorgan’s gold vault ever recorded.
Was someone anticipating something?
Once again, hopefully this crisis will be contained shortly. But if the Fed announces that it has decided to taper some more, that is going to be a signal to investors that they should race for the exits and the crisis in the emerging markets will get a whole lot worse.
And if you listen carefully, global officials are telling us that is precisely what we should expect. For example, consider the following statement from the finance minister of Mexico…
“We expected this year to be a volatile year for EM as the Fed tapers,” Mexican Finance Minister Luis Videgaray said, adding that volatility “will happen throughout the year as tapering goes on”.
Yes indeed – it is looking like this is going to be a very volatile year.
I hope that you are ready for what is coming next.