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The Drought In Brazil Has Gotten So Bad That 142 Cities Are Now Rationing Water

The Drought In Brazil Has Gotten So Bad That 142 Cities Are Now Rationing Water.

 By Michael Snyder, on February 18th, 2014 

Drought - Photo by Bert KaufmannDid you know that the drought in Brazil is so bad that some neighborhoods are only being allowed to get water once every three days?  At this point, 142 Brazilian cities are rationing water and there does not appear to be much hope that this crippling drought is going to end any time soon.  Unfortunately, most Americans seem to be absolutely clueless about all of this.  In response to my recent article about how the unprecedented drought that is plaguing California right now could affect our food supply, one individual left a comment stating “if Califirnia can’t supply South America will. We got NAFTA.”  Apart from the fact that this person could not even spell “California” correctly, we also see a complete ignorance of what is going on in the rest of the planet.  The truth is that the largest country in South America (Brazil) is also experiencing an absolutely devastating drought at the moment.  They are going to have a very hard time just taking care of their own people for the foreseeable future.

And this horrendous drought in Brazil could potentially have a huge impact on the total global food supply.  As a recent RT article detailed, Brazil is the leading exporter in the world in a number of very important food categories…

Over 140 Brazilian cities have been pushed to ration water during the worst drought on record, according to a survey conducted by the country’s leading newspaper. Some neighborhoods only receive water once every three days.

Water is being rationed to nearly 6 million people living in a total of 142 cities across 11 states in Brazil, the world’s leading exporter of soybeans, coffee, orange juice, sugar and beef. Water supply companies told the Folha de S. Paulo newspaper that the country’s reservoirs, rivers and streams are the driest they have been in 20 years. A record heat wave could raise energy prices and damage crops.

Some neighborhoods in the city of Itu in Sao Paulo state (which accounts for one-quarter of Brazil’s population and one-third of its GDP), only receive water once every three days, for a total of 13 hours.

Are you starting to see what I mean?

This is serious.

The drought in North America also continues to get even worse.  According to an expert interviewed by National Geographic, this drought in the state of California “could last for 200 years or more”…

B. Lynn Ingram, a paleoclimatologist at the University of California at Berkeley, thinks that California needs to brace itself for a megadrought—one that could last for 200 years or more.

As a paleoclimatologist, Ingram takes the long view, examining tree rings and microorganisms in ocean sediment to identify temperatures and dry periods of the past millennium. Her work suggests that droughts are nothing new to California.

A drought of even 10 years would absolutely cripple this nation.  Already, the size of the total U.S. cattle herd is the smallest that it has been in 63 years and California farmers are going to let half a million acres sit idle this year because of the extremely dry conditions.  If this drought persists for several more years we will have an unprecedented crisis on our hands.

Unfortunately, there are signs that this current drought in California may be part of a larger trend.  I had never heard of “the Pacific Decadal Oscillation” before this week, but apparently it is a phenomenon that can cause droughts that last “for decades“…

Ingram and other paleoclimatologists have correlated several historic megadroughts with a shift in the surface temperature of the Pacific Ocean that occurs every 20 to 30 years—something called the Pacific Decadal Oscillation (PDO). The PDO is similar to an El Nino event except it lasts for decades—as its name implies—whereas an El Nino event lasts 6 to 18 months. Cool phases of the PDO result in less precipitation because cooler sea temperatures bump the jet stream north, which in turn pushes off storms that would otherwise provide rain and snow to California. Ingram says entire lakes dried up in California following a cool phase of the PDO several thousand years ago.

And of course it isn’t just the western half of the country that is struggling with water supply problems.  In the Southeast, water has been a major political issue for quite some time

The drought-parched states of Georgia, Alabama and Florida are back at it — fighting for a slice of water rights in a decades-long water war that’s left all three thirsty for more.

The 24-year dispute is emblematic of an increasingly common economic problem facing cities and states across the country – the demand for water quickly outpacing the supply as spikes in population soak up resources.

Most of us that live in the United States are accustomed to having seemingly inexhaustible supplies of fresh water.  We use more fresh water per capita than anyone else on the planet, and most of us never even think twice about it.

Unfortunately, things are changing.  We are on the precipice of a great water crisis, and many Americans are going to be in for a very rude awakening.

And the frightening thing is that the U.S. is actually in much better shape than most of the rest of the world is when it comes to supplies of fresh water.  In some areas of the globe, a “water crisis” is already a daily reality.

We have heard that someday water is going to become the “new oil”, and we are starting to get to that point.  Life is simply not possible without water, and as global supplies of clean, fresh water dwindle it is inevitable that it is going to cause global tensions to rise.

So what do you think the solutions to these problems are?

Chinese Iron Ore Stockpiles Rise To Record As End Demand Plummets | Zero Hedge

Chinese Iron Ore Stockpiles Rise To Record As End Demand Plummets | Zero Hedge.

It may not be one of the core three (somewhat) realistic and accurate econometric indicators of China’s economy (which as a reminder according to premier Li Keqiang are electricity consumption, rail cargo volume and bank lending), but when it comes to getting a sense of capacity bottlenecks in China’s fixed investment pipeline – be it in ghost cities or the latest skyscraper building spree – nothing is quite as handy as commodity, and particularly iron ore (if not copper, which as we have explained before has a far more “monetary/letter of credit” function in China’s markets), stockpiles at China’s major ports. The logic is simple: no stockpiles means end demand by steelmakers is brisk and there is no inventory build up which in turns keep Australia, Brazil and other emerging markets happy. Alternatively, large stockpiles indicates something is very wrong with final demand, and hence, the overall economy.

One look at the chart below, which shows how much iron ore has been stockpiled at China’s 34 major ports (spoiler alert: it just hit an all time high), should explain at which of these two extremes China currently finds itself.

Here is what happened as explained by Market News:

Weak demand from steelmakers saw iron ore stockpiles at major ports hitting record highs, according to data from industry website umetal.com. Iron ore inventory at China’s 34 major ports jumped 4.56 million tons last week to 100.86 million tons as of February 14, the 2nd time it has surpassed the 100 million-ton level and matching the record of 2012. Iron ore imports were also at a record high in January, at 86.83 million tons, as steel traders boosted imports to bet on rising steel prices this year. But data from the China Iron and Steel Association showed crude steel output falling around 2% m/m in January. Average steel prices fell 0.79% last week, according to data compiled by mysteel.com.

There is another, more finely spun, explanation: monetary financing, or in other words, when it comes to China’s peculiar “generally accepted collateral”, iron is the new copper. Bloomberg explains:

Iron ore stockpiles in China, the world’s biggest buyer, climbed to a record as traders increased imports to use the steel-making raw material as collateral for credit and domestic demand remained weak.

“Imports kept piling up at ports as more cargoes are being hauled in for trade-financing deals,” Gao Bo, chief iron ore analyst at Mysteel.com, a researcher in Shanghai, said by phone from Beijing today.

While this may suggest end demand has not completely imploded, it does bring up a different set of complications: steel mill funding difficulties – perhaps the most sore topic in China nowadays.

Steel mills and trading firms in China are contending with increasing difficulty in getting funding, said Mysteel’s Gao.

“The funding situation in the steel industry was getting worse last month,” he said.

The weighted average lending rate in China was 7.2 percent in December, up from 6.22 percent a year earlier, central bank data released earlier this month show. In December, 63.4 percent of loans had interest rates above benchmarks, up from 59.7 percent a year earlier, according to the central bank.

However one spins it though, there is no denying that in addition to its on again, off again infautation with tapering and deleveraging, which usually continues right until the moment yet another shadow bank has to be bailed out, construction in China has slammed on the brakes:

Stockpiles of steel products also rose as construction activity remained weak after the Lunar New Year holidays, Gao said. Traders’ stockpiles of rebar, a building material, jumped by 65 percent this year to 8.55 million tons last week, according to Shanghai Steelhome.

One thing is certain – the biggest loser, as iron prices are set to tumble, will be Australia

Iron ore may drop more than previously forecast to $118 a ton this year as China will be unable to absorb record supply from Australia as growth slows, Judy Zhu, an analyst at Standard Chartered Plc, said last week.

Prices may average $119 a ton this quarter, $110 in second quarter and drop to $100 in the final period of this year, Goldman Sachs analysts led by Christian Lelong said in the Feb. 11 report.

Mine supply of iron ore reached a record over the fourth quarter of 2013, “with the natural destination being China,” Macquarie Group Ltd. said in a Feb. 13 report. “With inventory build being evidenced on the back of higher imports, this will act as a buffer to buyers in the coming months,” it said.

China’s shipments from Australia’s Port Hedland, the largest ore-export terminal, rose 27 percent to 23.3 million tons last month. Increased supply from Australia, the top ore shipper, may push the global seaborne surplus to 94.2 million tons this year from 9.1 million tons in 2013, UBS AG estimates.

Rio Tinto Group (RIO), the world’s second-biggest exporter, said last month that output rose 7 percent to 55.5 million tons last quarter from 52 million tons a year earlier. Fortescue Metals Group Ltd. is boosting capacity to 155 million tons by the end of March.

And speaking of Australian iron miners, it was in late summer of 2012 when Chinese iron ore stockpiles were once again in the 100 million ton range, when iron prices crashed so bad, that Fortescue was on insolvency watch. Should the current episode of collapsing Chinese end demand persist and construction freeze persist, it may be time to short to FMGAU bonds once again.

Unless of course, China once again unleashes the ghost cities building spree. Which it inevitably will: after all it has become all too clear that not one nation – neither Developing nor Emerging – will dare deviate from the current status quo course of unsustainable, superglued house of cards “muddle-through” until external, and internal, instability finally forces events into a world where everyone now has their head in the proverbial sand.

AP News : More than 140 Brazilian cities ration water

AP News : More than 140 Brazilian cities ration water.

Published: Today 

SAO PAULO (AP) – More than 140 cities are rationing water amid the worst drought to hit Brazil in decades, according to a survey conducted by the country’s leading newspaper.

The Folha de S. Paulo newspaper wrote Saturday that water is being rationed to close to six million people living in 142 cities in 11 states.

The newspaper quoted water supply companies saying reservoirs, rivers and streams are the driest they’ve been in 20 years.

Some neighborhoods in the city of Itu in Sao Paulo state only receive water for 13 hours, once every three days.

Water consumption normally grows by up to 20 percent during the Southern Hemisphere’s summer. But this year, consumption has risen by up to 30 percent due to a prolonged heat wave affecting several states.

The Cantareira water system, the largest of six that provide water to some 9 million of the 20 million people living in the metropolitan area of Sao Paulo city, is at less than 19 percent of its capacity of 1 trillion liters (264 billion gallons), water utility Sabesp said Saturday on its website.

Sabesp described the situation at Cantareira as “critical” because the amount of rain registered between December 2013 and January 2014 was the lowest in 84 years.

Sabesp said the other five water supply systems in Sao Paulo’s metropolitan area were normal for this time of year.

The PCJ Consorcio water association said the area would have to see 17 millimeters of rain a day for two months until Cantareira’s water level grows to 50 percent of its capacity.

Coffee to Soybean Wagers Climb on Brazilian Drought – Bloomberg

Coffee to Soybean Wagers Climb on Brazilian Drought – Bloomberg.

By Luzi Ann Javier  Feb 10, 2014 4:19 PM ET
Photographer: Dado Galdieri/Bloomberg

A woman harvests coffee beans at the Ponto Alegre estate farm in Cabo Verde, in the… Read More

Hedge funds raised bullish commodity bets to a 15-week high after a drought in Brazilthreatened crops from coffee to soybeans.

The net-long position across 18 U.S.-traded commodities climbed 15 percent to 900,330 futures and options in the week ended Feb. 4, the biggest gain since August, U.S. Commodity Futures Trading Commission data show. Investors turned bullish on arabica coffee for the first time since July 2012 and soybean wagers rose by the most in almost three months. Brazil is the biggest exporter of both crops.

The Standard & Poor’s GSCI Agriculture Index of eight commodities rose 3.3 percent last week, reaching an eight-week high Feb. 6. In Brazil, also the top sugar grower, the driest January since 1954 drained dams and scorched plants. Extreme global weather also is threatening other crops with too much rain hampering Indonesia’s cocoa harvest and freezing temperatures damaging U.S. wheat.

“Agriculture is probably the best hope for a decent commodity run this year,” said Peter Sorrentino, who helps manage $4.4 billion at Huntington Asset Advisors in Cincinnati. “These weather issues will definitely have a decided positive influence on prices.”

The S&P GSCI Spot Index of 24 raw materials gained 2.1 percent last week. The MSCI All-Country World index of equities rose 0.8 percent, while the Bloomberg Treasury Bond Index slid 0.1 percent. The Bloomberg Dollar Spot Index, a gauge against 10 major trading partners, dropped 0.8 percent. The S&P GSCI Agriculture Index rose 0.2 percent at 4:18 p.m. New York time.

Coffee Bulls

Money managers held a coffee net-bullish position of 7,981 contracts on Feb. 4, the CFTC data show. That’s the first bet on a rally since July 2012. Prices for arabica, the variety favored by Starbucks Corp., surged 23 percent since Dec. 31, the best start to a year since 1997.

Plantations in Brazil are enduring dry weather just when rain is needed the most for tree roots to absorb nutrients as the beans begin to grow inside the coffee cherries. Rain may be “too late” and there isn’t enough time to reverse the damage to trees and beans, Terra Forte, a Sao Joao da Boa Vista-based shipper, said in a report.

Hot, dry weather cut potential soybean yields in as much as 40 percent of Brazil’s growing areas, Commodity Weather Group LLC in Bethesda, Maryland, said in a report Feb. 7. In Kansas, the top winter-wheat-growing state, 35 percent of the crop was in good or excellent condition, down from 58 percent on Dec. 30 after sub-zero temperatures swept the nation, the government said Feb. 3. The Indonesian Cocoa Association sees the nation’s crop dropping to the lowest in a decade as rains in the third-biggest grower hurt flowering and delay the harvest.

Goldman, Citi

Raw materials from copper and corn to sugar and coffee will be have supply surpluses this year after a decade-long bull market spurred producers to build new mines, drill more wells and expand planting of crops. Banks led by Goldman Sachs Group Inc. and Citigroup Inc. say commodities are heading for losses in 2014. The S&P GSCI Agriculture Index tumbled 22 percent last year, the most since 1981, after U.S. crops recovered from the worst drought since the 1930s.

Inventories of soybeans around the world will equal 26.7 percent of consumption this season, up from 23.5 percent a year earlier, the U.S. Department of Agriculture said Jan. 10. Corn stockpiles will equal 17.1 percent of use, compared with 15.4 percent a year earlier. Global coffee production is set to exceed demand for a fourth season, pushing stockpiles to a five-year high, according to the USDA.

Supply ‘Buffer’

“We’re not in a precarious situation for crop supplies like we were a year ago,” said Kelly Wiesbrock, a managing director at Harvest Capital Strategies in San Francisco, which oversees $1.8 billion. “We do have a buffer today in the event that we have below-trend yields this year. It’s unlikely we see drastic price reaction.”

World food prices fell in January to a 19-month low, the United Nations’ Food & Agriculture Organization said Feb. 6. The Rome-based group’s index of 55 food items is 4.5 percent lower than a year ago.

The S&P GSCI Enhanced Commodity Index, Goldman’s preferred measure, will drop 3 percent in the next 12 months, the bank said in a Jan. 12 report. Precious metals will lead losses with a 15 percent drop, while agriculture will decline 11 percent.

Money managers increased their net-bullish soybean holdings by 20 percent to 146,533 contracts, the highest this year. Prices gained 3.8 percent last week, the most since August. Cocoa wagersgained 7.2 percent to 83,038, a second straight increase. Investors held a net-short position of 52,963 in wheat, compared with 62,501 a week earlier.

Gold Wagers

Wagers on a gold rally slid 2.1 percent to 59,408 contracts, the first decline this year, the CFTC data show. Federal Reserve officials said Jan. 29 they would trim monthly purchases of bonds to $65 billion from $75 billion, after a $10 billion cut announced in December. Bullion rose 70 percent from December 2008 to June 2011 as the Fed pumped more than $2 trillion into the financial system.

Gold rebounded 5.6 percent this year after a 28 percent decline in 2013 that was the biggest since 1981. About $1.6 trillion was erased from the value of global equities in 2014 amid signs of slow economic growth in China and a slump in emerging-market currencies. Sales of gold coins by the U.S. Mint rose 63 percent in January to the highest since April.

Copper Inventories

Investors became bearish on copper before prices capped the biggest rally this year. Funds are holding a net-short position of 6,832 contracts, compared with a net-long of 11,735 a week earlier. Futures in New York rose 1.2 percent last week, the most since Dec. 27. Inventories at warehouses monitored by the London Metal Exchange declined 16 percent this year to the lowest since December 2012.

“Commodities, especially base metals, might be getting to close to a point where investors have discounted something close to a worst-case scenario,” said Sameer Samana, a senior international strategist at Wells Fargo Advisors LLC, which oversees about $1.4 trillion. “There will be pockets of strength. The issue in Brazil could be a catalyst.”

To contact the reporter on this story: Luzi Ann Javier in New York at ljavier@bloomberg.net

To contact the editor responsible for this story: Millie Munshi at mmunshi@bloomberg.net

Rio fare hike protests turn violent – Americas – Al Jazeera English

Rio fare hike protests turn violent – Americas – Al Jazeera English.

Police and protesters clash in Brazilian city’s main train station in a demonstration against a 10-cent bus fare hike.

Last updated: 07 Feb 2014 08:26

Members of the “Free Pass” movement invaded the station to demand zero tariffs in Rio de Janeiro [Reuters]
Police and protesters violently clashed in Rio de Janeiro’s main train station in a demonstration against a 10-cent hike in bus fare.A cameraman for Band TV was hit in the head by either a stun grenade launched by police or a homemade explosive tossed by protesters; it was not immediately clear which.

Band said in a statement that cameraman Santiago Andrade was taken to a hospital by police and underwent surgery. He is in serious condition.

It is the latest protest to hit Brazil since last June, when nationwide demonstrations broke out after a sharp police crackdown on a group in Sao Paulo that was marching against an increase in public transportation fares.

That increase was reversed in the face of protesters’ pressure.

Rio Mayor Eduardo Paes recently approved a 10-cent increase for bus fares starting this Saturday.

About 800 protesters had peacefully gathered on Thursday in central Rio before they started marching to the city’s main train station, some holding aloft signs condemning the billions of dollars spent to host the World Cup, money they want used for better hospitals, schools and infrastructure.

Clashes broke out inside the train station after demonstrators began jumping over turnstiles and police used batons and tear gas to disperse members of the Black Block anarchist tactic.

Police pushed the demonstrators outside and used more tear gas to disperse those gathered, while demonstrators hurled rocks at the officers.

Authorities were forced to close the station, leaving thousands of commuters stranded. Some bystanders were made ill by the tear gas, while others fainted.

Thais Jorao, a 22-year-old protester, said that demonstration was not simply because of the 10-cent bus fare hike.

“If it was a public transportation fare hike when we had good health services and education, you wouldn’t have this many people on the street,” he said.

“On top of this you see spending with the World Cup, things that we really don’t need. We want health, education, decent public transportation.”

What Blows Up First? Part 3: Subprime Countries

What Blows Up First? Part 3: Subprime Countries.

by John Rubino on January 27, 2014 

One of the reasons the rich countries’ excessive money creation hasn’t ignited a generalized inflation is that today’s global economy is, well, global. When the Fed dumps trillions of dollars into the US banking system, that liquidity is free to flow wherever it wants. And in the past few years it has chosen to visit Brazil, China, Thailand, and the rest of the developing world.

This tidal wave of hot money bid up asset prices and led emerging market governments and businesses to borrow a lot more than they would have otherwise. Like the recipients of subprime mortgages in 2006, they were seduced by easy money and fooled into placing bets that could only work out if the credit kept flowing forever.

Then the Fed, spooked by nascent bubbles in equities and real estate, began to talk about scaling back its money printing*. The hot money started flowing back into the US and out of the developing world. And again just like subprime mortgages, the most leveraged and/or badly managed emerging markets have begun to implode, threatening to pull down everyone else. A sampling of recent headlines:

Contagion Spreads in Emerging Markets as Crises Grow

Investors Flee Developing World

Erosion of Argentine Peso Sends a Shudder Through Latin America

The Entire World is Unraveling Before Our Eyes

Chinese Debt Debacle Supports Soros’ ‘Eerie’ Portrayal

Venezuela Enacts “Law of Fair Prices”

Argentina Returns to Villa Miseria

Indian Rupee Falls to 2-Month Low; Joins Emerging Market Sell-Off

Turkey’s ‘Embarrassing’ Intervention Fails to Curb Lira Sell-Off

Prudent Bear’s Doug Noland as usual gets it exactly right in his most recent Credit Bubble Bulletin. Here are a few excerpts from a much longer article that should be read by everyone who wants to understand the causes and implications of the emerging-market implosion:

Virtually the entire emerging market “complex” has been enveloped in protracted destabilizing financial and economic Bubbles. In particular, for five years now unprecedented “developed” world central bank-induced liquidity has spurred unsound economic and financial booms. The massive investment and “hot money” flows are illustrated by the multi-trillion growth of EM central bank international reserve holdings. There have of course been disparate resulting impacts on EM financial and economic systems. But I believe in all cases this tsunami of liquidity and speculation has had deleterious consequences, certainly including fomenting systemic dependencies to foreign-sourced flows. In seemingly all cases, protracted Bubbles have inflated societal expectations.

For a while, central bank willingness to use reserves to support individual currencies bolsters market confidence in a country’s currency, bonds and financial system more generally. But at some point a central bank begins losing the battle to accelerating outflows. A tough decision is made to back away from market intervention to safeguard increasingly precious reserve holdings. Immediately, the marketplace must then contend with a faltering currency, surging yields, unstable financial markets and rapidly waning liquidity generally. Things unravel quickly.

The issue of EM sovereign and corporate borrowings in dollar (and euro and yen) denominated debt has speedily become a critical “macro” issue. More than five years of unprecedented global dollar liquidity excess spurred a historic boom in dollar-denominated borrowings. The marketplace assumed ongoing dollar devaluation/EM currency appreciation. There became essentially insatiable market demand for higher-yielding EM debt, replete with all the distortions in risk perceptions, market mispricing and associated maladjustment one should expect from years of unlimited cheap finance. As was the case with U.S. subprime, it’s always the riskiest borrowers that most intensively feast at the trough of easy “money.”

So, too many high-risk borrowers – from vulnerable economies and Credit systems – accumulated debt denominated in U.S. and other foreign currencies – for too long. Now, currencies are faltering, “hot money” is exiting, Credit conditions are tightening and economic conditions are rapidly deteriorating. It’s a problematic confluence that will find scores of borrowers challenged to service untenable debt loads, especially for borrowings denominated in appreciating non-domestic currencies. This tightening of finance then becomes a pressing economic issue, further pressuring EM currencies and financial systems – the brutal downside of a protracted globalized Credit and speculative cycle.

In many cases, this was all part of a colossal “global reflation trade.” Today, many EM economies confront the exact opposite: mounting disinflationary forces for things sold into global markets. Falling prices, especially throughout the commodities complex, have pressured domestic currencies. This became a major systemic risk after huge speculative flows arrived in anticipation of buoyant currencies, attractive securities markets, and enticing business opportunities. The commodities boom was to fuel general and sustained economic booms. EM was to finally play catchup to “developed.”

Now, Bubbles are faltering right and left – and fearful “money” is heading for the (closing?) exits. And, as the global pool of speculative finance reverses course, the scale of economic maladjustment and financial system impairment begins to come into clearer focus. It’s time for the marketplace to remove the beer goggles.

No less important is the historic – and ongoing – boom in manufacturing capacity in China and throughout Asia. This has created excess capacity and increasing pricing pressure for too many manufactured things, a situation only worsened by Japan’s aggressive currency devaluation. This dilemma, with parallels to the commodity economies, becomes especially problematic because of the enormous debt buildup over recent years. While this is a serious issue for the entire region, it has become a major pressing problem in China.

At the same time, data this week provided added confirmation (see “China Bubble Watch”) that China’s spectacular apartment Bubble continues to run out of control. When Chinese officials quickly backed away from Credit tightening measures this past summer, already overheated housing markets turned even hotter. Now officials confront a dangerous situation: Acute fragility in segments of its “shadow” financing of corporate and local government debt festers concurrently with ongoing “terminal phase” excess throughout housing finance. China’s financial and economic systems have grown dependent upon massive ongoing Credit expansion, while the quality of new Credit is suspect at best. It’s that fateful “terminal phase” exponential growth in systemic risk playing out in historic proportions. Global markets have begun to take notice.

There are critical market issues with no clear answers. For one, how much speculative “hot money” has and continues to flood into China to play their elevated yields in a currency that is (at the least) expected to remain pegged to the U.S. dollar? If there is a significant “hot money” issue, any reversal of speculative flows would surely speed up this unfolding Credit crisis. And, of course, any significant tightening of Chinese Credit would reverberate around the globe, especially for already vulnerable EM economies and financial systems.

No less important is the historic – and ongoing – boom in manufacturing capacity in China and throughout Asia. This has created excess capacity and increasing pricing pressure for too many manufactured things, a situation only worsened by Japan’s aggressive currency devaluation. This dilemma, with parallels to the commodity economies, becomes especially problematic because of the enormous debt buildup over recent years. While this is a serious issue for the entire region, it has become a major pressing problem in China.

The crucial point here is that this crisis is not a case of one or two little countries screwing up. It’s everywhere, from Latin America to Asia to Eastern Europe. Each country’s problems are unique, but virtually all can be traced back to the destabilizing effects of hot money created by rich countries attempting to export their debt problems to the rest of the world. ZIRP, QE and all the rest succeeded for a while in creating the illusion of recovery in the US, Europe and Japan, but now it’s blow-back time. The mess we’ve made in the subprime countries will, like rising defaults on liar loans and interest-only mortgages in 2007, start moving from periphery to core. As Noland notes:

Yet another crisis market issue became more pressing this week. The Japanese yen gained 2.0% versus the dollar. Yen gains were even more noteworthy against other currencies. The yen rose 4.2% against the Brazilian real, 3.9% versus the Chilean peso, 3.5% against the Mexican peso, 3.9% versus the South African rand, 3.8% against the South Korean won, 3.0% versus the Canadian dollar and 3.0% versus the Australian dollar.

I have surmised that the so-called “yen carry trade” (borrow/short in yen and use proceeds to lever in higher-yielding instruments) could be the largest speculative trade in history. Market trading dynamics this week certainly did not dissuade. When the yen rises, negative market dynamics rather quickly gather momentum. From my perspective, all the major speculative trades come under pressure when the yen strengthens; from EM, to the European “periphery,” to U.S. equities and corporate debt.

It’s worth noting that the beloved European “periphery” trade reversed course this week. The spread between German and both Spain and Italy 10-year sovereign yields widened 19 bps this week. Even the France to Germany spread widened 6 bps this week to an almost 9-month high (72bps). Stocks were slammed for 5.7% and 3.1% in Spain and Italy, wiping out most what had been strong January gains.

Even U.S. equities succumbed to global pressures. Notably, the cyclicals and financials were hit hard. Both have been Wall Street darlings on the bullish premise of a strengthening U.S. (and global) recovery and waning Credit and financial risk. Yet both groups this week seemed to recognize the reality that what is unfolding in China and EM actually matter – and they’re not pro-global growth. With recent extreme bullish sentiment, U.S. equities would appear particularly vulnerable to a global “risk off” market dynamic.

To summarize: 
Developed world banks have lent hundreds of billions of dollars to emerging market businesses and governments. If these debts go bad, those already-impaired banks will be looking at massive, perhaps fatal losses. Meanwhile, trillions of dollars of derivatives have been written by banks and hedge funds on emerging market debt and currencies, with money center banks serving as counterparties on both sides of these contracts. They net out their long and short exposures to hide the true risk, but let just one major counterparty fail and the scam will be exposed, as it was in 2008 when AIG’s implosion nearly bankrupted Goldman Sachs and JP Morgan Chase.

Last but not least, individuals and pension funds in the developed world have invested hundreds of billions of dollars in emerging market stock and bond funds, which are now looking like huge year-ahead losers. The global balance sheet, in short, is about to get a lot more fragile.

So, just as pretty much everyone in the sound money community predicted, tapering will end sooner rather than later when a panicked Fed announces some kind of bigger and better shock-and-awe debt monetization plan. The European Central Bank, which actually shrank its balance sheet in 2013, will reverse course and start monetizing debt on a vast scale. As for Japan, who knows what they can get away with, since their government debt is, as a percentage of GDP, already twice that of the US.

The real question is not whether more debt monetization is coming, but whether it will come soon enough to preserve the asset price bubbles that are right this minute being punctured by the emerging market implosion. If not, it really is 2008 all over again.

The previous articles in this series:

What Blows Up First, Part 1: Europe

What Blows Up First, Part 2: Japan

“Money printing” in this case refers to currency creation in all its forms, electronic and physical.

 

Who Are The Biggest Losers From The EM Crisis | Zero Hedge

Who Are The Biggest Losers From The EM Crisis | Zero Hedge.

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.

The IMF’s Emerging Confusion On Emerging Markets | Zero Hedge

The IMF’s Emerging Confusion On Emerging Markets | Zero Hedge.

The IMF’s woeful forecasting record, chronicled extensively before, has just taken yet another hit, following the latest flip flop on emerging markets. Try to spot the common theme of these assessments by the IMF.

IMF Chief economist Olivier Blanchard, April 11, 2011 (source):

In emerging market economies, by contrast, the crisis left no lasting wounds. Their initial fiscal and financial positions were typically stronger, and the adverse effects of the crisis were more muted. High underlying growth and low interest rates are making fiscal adjustment much easier. Exports have recovered, and whatever shortfall in external demand they experienced has typically been made up through increases in domestic demand. Capital outflows have turned into capital inflows, due to both better growth prospects and higher interest rates than in the advanced economies. The challenge for most emerging market economies is thus quite different from that of the advanced economies—namely, how to avoid overheating in the face of closing output gaps and higher capital flows.”

IMF Chief economist Olivier Blanchard, July 9, 2013 (source):

“If you look country by country it seems to be specific . . . so in China it looks like unproductive investment, in Brazil it looks like low investment and in India it looks like policy and administrative uncertainty. But you wonder whether there is not something behind. I think behind this is a slowdown in underlying growth – not the cyclical component but just the average rate. It’s clear that these countries are not going to grow as fast as they did before the crisis.”

IMF Chief economist Olivier Blanchard, January 23, 2014 (source)

“Finally, we forecast that both emerging market and developing economies will sustain strong growth

A few days later, EMs around the globe crashed, and central banks virtually everywhere had to step in to bail out their crashing currencies, and hit the tape with even more impressive verbal intervention every several hours.

Finally, today we get IMF economist Alejandro Werner, January 30, 2014 (source)

“Conditions in global financial markets will stay tighter than they were before the U.S. central bank’s “taper talk” in the first half of 2013, translating into higher international borrowing costs,particularly with the recent volatility in emerging markets…. sustained turbulence in emerging markets could tighten global financial conditions further…. Rebuilding fiscal buffers, and using monetary policy and flexible exchange rates to absorb shocks where possible, remains the order of the day.

In other words, going from a forecast of “high underlying growth”, to “not going to grow as fast as they did”, to “sustain strong growth”, to violent EM crash, to “turbulence”, “volatility”, and urging EMs to “using monetary policy to absorb shocks”, what is clear is that nobody knows what is going on, nobody has any handle on the future of Emerging Markets, but let’s all just pretend that the MIT central-planners in control, are in control, and all shall be well.

The Emerging Market Collapse Through The Eyes Of Don Corleone | Zero Hedge

The Emerging Market Collapse Through The Eyes Of Don Corleone | Zero Hedge.

Submitted by Ben Hunt of Epsilon Theory

It Was Barzini All Along

Tattaglia is a pimp. He never could have outfought Santino. But I didn’t know until this day that it was Barzini all along.

— Don Vito Corleone

Like many in the investments business, I am a big fan of the Godfather movies, or at least those that don’t have Sofia Coppola in a supporting role. The strategic crux of the first movie is the realization by Don Corleone at a peace-making meeting of the Five Families that the garden variety gangland war he thought he was fighting with the Tattaglia Family was actually part of an existential war being waged by the nominal head of the Families, Don Barzini. Vito warns his son Michael, who becomes the new head of the Corleone Family, and the two of them plot a strategy of revenge and survival to be put into motion after Vito’s death. The movie concludes with Michael successfully murdering Barzini and his various supporters, a plot arc that depends entirely on Vito’s earlier recognition of the underlying cause of the Tattaglia conflict. Once Vito understood WHY Philip Tattaglia was coming after him, that he was just a stooge for Emilio Barzini, everything changed for the Corleone Family’s strategy.

Now imagine that Don Corleone wasn’t a gangster at all, but was a macro fund portfolio manager or, really, any investor or allocator who views the label of “Emerging Market” as a useful differentiation … maybe not as a separate asset class per se, but as a meaningful way of thinking about one broad set of securities versus another. With the expansion of investment options and liquid securities that reflect this differentiation — from Emerging Market ETF’s to Emerging Market mutual funds — anyone can be a macro investor today, and most of us are to some extent.

You might think that the ease with which anyone can be an Emerging Markets investor today would make the investment behavior around these securities more complex from a game theory perspective as more and more players enter the game, but actually just the opposite is true. The old Emerging Markets investment game had very high informational and institutional barriers to entry, which meant that the players relied heavily on their private information and relatively little on public signals and Common Knowledge. There may be far more players in the new Emerging Markets investment game, but they are essentially one type of player with a very heavy reliance on Common Knowledge and public Narratives. Also, these new players are not (necessarily) retail investors, but are (mostly) institutional investors that see Emerging Markets or sub-classifications of Emerging Markets as an asset class with certain attractive characteristics as part of a broad portfolio. Because these institutional investors have so much money that must be put to work and because their portfolio preference functions are so uniform, there is a very powerful and very predictable game dynamic in play here.

Since the 2008 Crisis the Corleone Family has had a pretty good run with their Emerging Markets investments, and even more importantly Vito believes that he understands WHY those investments have worked. In the words of Olivier Blanchard, Chief Economist for the IMF:

In emerging market countries by contrast, the crisis has not left lasting wounds. Their fiscal and financial positions were typically stronger to start, and adverse effects of the crisis have been more muted. High underlying growth and low interest rates are making fiscal adjustment much easier. Exports have largely recovered, and whatever shortfall in external demand they experienced has typically been made up through an increase in domestic demand. Capital outflows have turned into capital inflows, due to both better growth prospects and higher interest rates than in advanced countries. … The challenge for most emerging countries is quite different from that of advanced countries, namely how to avoid overheating in the face of closing output gaps and higher capital flows. — April 11, 2011

As late as January 23rd of this year, Blanchard wrote that “we forecast that both emerging market and developing economies will sustain strong growth“.

Now we all know what actually happened in 2013. Growth has been disappointing around the world, particularly in Emerging Markets, and most of these local stock and bond markets have been hit really hard. But if you’re Vito Corleone, macro investor extraordinaire, that’s not necessarily a terrible thing. Sure, you don’t like to see any of your investments go down, but Emerging Markets are notably volatile and maybe this is a great buying opportunity across the board. In fact, so long as the core growth STORY is intact, it almost certainly is a buying opportunity.

But then you wake up on July 9th to read in the WSJ that Olivier Blanchard has changed his tune. He now says “It’s clear that these countries [China, Russia, India, Brazil, South Africa] are not going to grow at the same rate as they did before the crisis.” Huh? Or rather, WTF? How did the Chief Economist of the IMF go from predicting “strong growth” to declaring that the party is over and the story has fundamentally changed in six months?

It’s important to point out that Blanchard is not some inconsequential opinion leader, but is one of the most influential economists in the world today. His position at the IMF is a temporary gig from his permanent position as the Robert M. Solow Professor of Economics at MIT, where he has taught since 1983. He also received his Ph.D. in economics from MIT (1977), where his fellow graduate students were Ben Bernanke (1979), Mario Draghi (1976), and Paul Krugman (1977), among other modern-day luminaries; Stanley Fischer, current Governor of the Bank of Israel, was the dissertation advisor for both Blanchard and Bernanke; Mervyn King and Larry Summers (and many, many more) were Blanchard’s contemporaries or colleagues at MIT at one point or another. The centrality of MIT to the core orthodoxy of modern economic theory in general and monetary policy in particular has been well documented by Jon Hilsenrath and others and it’s not a stretch to say that MIT provided a personal bond and a formative intellectual experience for a group of people that by and large rule the world today. Suffice it to say that Blanchard is smack in the middle of that orthodoxy and that group. I’m not saying that anything Blanchard says is amazingly influential in and of itself, certainly not to the degree of a Bernanke or a Draghi (or even a Krugman), but I believe it is highly representative of the shared beliefs and opinions that exist among these enormously influential policy makers and policy advisors. Two years ago the global economic intelligentsia believed that Emerging Markets had emerged from the 2008 crisis essentially unscathed, but today they believe that EM growth rates are permanently diminished from pre-crisis levels. That’s a big deal, and anyone who invests or allocates to “Emerging Markets” as a differentiated group of securities had better take notice.

Here’s what I think happened.

First, an error pattern has emerged over the past few years from global growth data and IMF prediction models that forced a re-evaluation of those models and the prevailing Narrative of “unscathed” Emerging Markets. Below is a chart showing actual Emerging Market growth rates for each year listed, as well as the IMF prediction at the mid-year mark within that year and the mid-year mark within the prior year (generating an 18-month forward estimate).

Pre-crisis the IMF systematically under-estimated growth in Emerging Markets. Post-crisis the IMF has systematically over-estimated growth in Emerging Markets. Now to be sure, this IMF over-estimation of growth exists for Developed Markets, too, but between the EuroZone sovereign debt crisis and the US fiscal cliff drama there’s a “reason” for the unexpected weakness in Developed Markets. There’s no obvious reason for the persistent Emerging Market weakness given the party line that “whatever shortfall in external demand they experienced has typically been made up through an increase in domestic demand.” Trust me, IMF economists know full well that their models under-estimated EM growth pre-crisis and have now flipped their bias to over-estimate growth today. Nothing freaks out a statistician more than this sort of flipped sign. It means that a set of historical correlations has “gone perverse” by remaining predictive, but in the opposite manner that it used to be predictive. This should never happen if your underlying theory of how the world works is correct. So now the IMF (and every other mainstream macroeconomic analysis effort in the world) has a big problem. They know that their models are perversely over-estimating growth, which given the current projections means that we’re probably looking at three straight years of sub-5% growth in Emerging Markets (!!) more than three years after the 2008 crisis ended, and — worse — they have no plausible explanation for what’s going on.

Fortunately for all concerned, a Narrative of Central Bank Omnipotence has emerged over the past nine months, where it has become Common Knowledge that US monetary policy is responsible for everything that happens in global markets, for good and for ill (see “How Gold Lost Its Luster”). This Narrative is incredibly useful to the Olivier Blanchard’s of the world, as it provides a STORY for why their prediction models have collapsed. And maybe it really does rescue their models. I have no idea. All I’m saying is that whether the Narrative is “true” or not, it will be adopted and proselytized by those whose interests — bureaucratic, economic, political, etc. — are served by that Narrative. That’s not evil, it’s just human nature.

Nor is the usefulness of the Narrative of Central Bank Omnipotence limited to IMF economists. To listen to Emerging Market central bankers at Jackson Hole two weeks ago or to Emerging Market politicians at the G-20 meeting last week you would think that a great revelation had been delivered from on high. Agustin Carstens, Mexico’s equivalent to Ben Bernanke, gave a speech on the “massive carry trade strategies” caused by ZIRP and pleaded for more Fed sensitivity to their capital flow risks. Interesting how the Fed is to blame now that the cash is flowing out, but it was Mexico’s wonderful growth profile to credit when the cash was flowing in. South Africa’s finance minister, Pravin Gordhan, gave an interview to the FT from Jackson Hole where he bemoaned the “inability to find coherent and cohesive responses across the globe to ensure that we reduce the volatility in currencies in particular, but also in sentiment” now that the Fed is talking about a Taper. Christine Lagarde got into the act, of course, calling on the world to build “further lines of defense” even as she noted that the IMF would (gulp) have to stand in the breach as the Fed left the field. To paraphrase Job: the Fed gave, and the Fed hath taken away; blessed be the name of the Fed.

The problem, though, is that once you embrace the Narrative of Central Bank Omnipotence to “explain” recent events, you can’t compartmentalize it there. If the pattern of post-crisis Emerging Market growth rates is largely explained by US monetary accommodation or lack thereof … well, the same must be true for pre-crisis Emerging Market growth rates. The inexorable conclusion is that Emerging Market growth rates are a function of Developed Market central bank liquidity measures and monetary policy, and that all Emerging Markets are, to one degree or another, Greece-like in their creation of unsustainable growth rates on the back of 20 years of The Great Moderation (as Bernanke referred to the decline in macroeconomic volatility from accommodative monetary policy) and the last 4 years of ZIRP. It was Barzini all along!

This shift in the Narrative around Emerging Markets — that the Fed is the “true” engine of global growth — is a new thing. As evidence of its novelty, I would point you to another bastion of modern economic orthodoxy, the National Bureau of Economic Research (NBER), in particular their repository of working papers. Pretty much every US economist of note in the past 40 years has published an NBER working paper, and I only say “pretty much every” because I want to be careful; my real estimate is that there are zero mainstream US economists who don’t have a working paper here.

If you search the NBER working paper database for “emerging market crises”, you see 16 papers. Again, the author list reads like a who’s who of famous economists: Martin Feldstein, Jeffrey Sachs, Rudi Dornbusch, Fredric Mishkin, Barry Eichengreen, Nouriel Roubini, etc. Of these 16 papers, only 2 — Frankel and Roubini (2001) and Arellano and Mendoza (2002) — even mention the words “Federal Reserve” in the context of an analysis of these crises, and in both cases the primary point is that some Emerging Market crises, like the 1998 Russian default, force the Fed to cut interest rates. They see a causal relationship here, but in the opposite direction of today’s Narrative! Now to be fair, several of the papers point to rising Developed Market interest rates as a “shock” or contributing factor to Emerging Market crises, and Eichengreen and Rose (1998) make this their central claim. But even here the argument is that “a one percent increase in Northern interest rates is associated with an increase in the probability of Southern banking crises of around three percent” … not exactly an earth-shattering causal relationship. More fundamentally, none of these authors ever raise the possibility that low Developed Market interest rates are the core engine of Emerging Market growth rates. It’s just not even contemplated as an explanation.

Today, though, this new Narrative is everywhere. It pervades both the popular media and the academic “media”, such as the prominent Jackson Hole paper by Helene Rey of the London Business School, where the nutshell argument is that global financial cycles are creatures of Fed policy … period, end of story. Not only is every other country just along for the ride, but Emerging Markets are kidding themselves if they think that their plight matters one whit to the US and the Fed.

Market participants today see Barzini/Bernanke everywhere, behind every news announcement and every market tick. They may be right. They may be reading the situation as smartly as Vito Corleone did. I doubt it, but it really doesn’t matter. Whether or not I privately believe that Barzini/Bernanke is behind everything that happens in the world, I am constantly told that this is WHY market events happen the way they do. And because I know that everyone else is seeing the same media explanations of WHY that I am seeing … because I know that everyone else is going through the same tortured decision process that I’m going through … because I know that everyone else is thinking about me in the same way that I am thinking about them … because I know that if everyone else acts as if he or she believes the Narrative then I should act as if I believe the Narrative … then the only rational conclusion is that I should act as if I believe it. That’s the Common Knowledge game in action. This is what people mean when they say that a market behavior of any sort “takes on a life of its own.”

For the short term, at least, the smart play is probably just to go along with the Barzini/Bernanke Narrative, just like the Corleone family went along with the idea that Barzini was running them out of New York (and yes, I understand that at this point I’m probably taking this Godfather analogy too far). By going along I mean thinking of the current market dynamic in terms of risk management, understanding that the overall information structure of this market is remarkably unstable. Risk-On / Risk-Off behavior is likely to increase significantly in the months ahead, and there’s really no predicting when Bernanke will open his mouth or what he’ll say, or who will be appointed to take his place, or what he or she will say. It’s hard to justify any large exposure to public securities in this environment, long or short, because all public securities will be dominated by this Narrative so long as everyone thinks that everyone thinks they will be dominated. This the sort of game can go on for a long time, particularly when the Narrative serves the interests of incredibly powerful institutions around the world.

But what ultimately saved the Corleone family wasn’t just the observation of Barzini’s underlying causal influence, it was the strategy that adjusted to the new reality of WHY. What’s necessary here is not just a gnashing of teeth or tsk-tsk’ing about how awful it is that monetary policy has achieved such behavioral dominance over markets, but a recognition that it IS, that there are investment opportunities created by its existence, and that the greatest danger is to continue on as if nothing has changed.

I believe that there are two important investment implications that stem from this sea change in the Narrative around Emerging Markets, which I’ll introduce today and develop at length in subsequent notes.

First, I think it’s necessary for active investors to recalibrate their analysis towards individual securities that happen to be found in Emerging Markets, not aggregations of securities with an “Emerging Markets” label. I say this because in the aggregate, Emerging Market securities (ETF’s, broad-based funds, etc.) are now the equivalent of a growth stock with a broken story, and that’s a very difficult row to hoe. Take note, though, the language you will have to speak in this analytic recalibration of Emerging Market securities is Value, not Growth, and the critical attribute of a successful investment will have little to do with the security’s inherent qualities (particularly growth qualities) but a great deal to do with whether a critical mass of Value-speaking investors take an interest in the security.

Second, there’s a Big Trade here related to the predictable behaviors and preference functions of the giant institutional investors or advisors that — by size and by strategy — are locked into a perception of Emerging Market meaning that can only be expressed through aggregations of securities or related fungible asset classes (foreign exchange and commodities). These mega-allocators do not “see” Emerging Markets as an opportunity set of individual securities, but as an asset class with useful diversification qualities within an overall portfolio. So long as market behaviors around Emerging Markets in the aggregate are driven by the Barzini/Bernanke Narrative, that diversification quality will decline, as the same Fed-speak engine is driving behaviors in both Emerging Markets and Developed Markets. Mega-allocators care more about diversification and correlations than they do about price, which means that the selling pressure will continue/increase so long as the old models aren’t working and the Barzini/Bernanke Narrative diminishes what made Emerging Markets as an asset class useful to these institutions in the first place. But when that selling pressure dissipates — either because the Barzini/Bernanke Narrative wanes or the mega-portfolios are balanced for the new correlation models that take the Barzini/Bernanke market effect into account — that’s when Emerging Market securities in the aggregate will work again. You will never identify that turning point in Emerging Market security prices by staring at a price chart. To use a poker analogy you must play the player — in this case the mega-allocators who care a lot about correlation and little about price — not the cards in order to know when to place a big bet.

In future weeks I’ll be expanding on each of these investment themes, as well as taking them into the realm of foreign exchange and commodities. Also, there’s a lot still to be said about Fed communication policy and the Frankenstein’s Monster it has become. I hope you will join me for the journey, and if you’d like to be on the direct distribution list for these free weekly notes please sign up at Follow Epsilon Theory.

Are We On The Verge Of A Massive Emerging Markets Currency Collapse?

Are We On The Verge Of A Massive Emerging Markets Currency Collapse?.

Currency CollapseThis 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.

Wheelbarrow of Money

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