Excerpted from the upcoming October Global Macro Tipping Points
at GordonTLong.com
Released 09/07/13
Have the peripheral BRICS hit a brick wall? After years as investor havens
with stellar performance, has the luster been tarnished and something much
darker started to cast a dark shadow?
The just concluded G20 Summit in St Petersburg, Russia sheds light on the
seriousness of the concern surrounding the plummeting currencies in three
of the BRICS (Brazil, India and South Africa).
Away from the glare of the media, the BRICS according the ChinaDaily cobbled
together an emergency
$100B currency reserve 'Firewall Fund'. The BRICS are obviously worried.
The 1997 Asia Crisis taught emerging economies the importance of strong currency
reserve positions in event that 'hot' capital flows became volatile and changed
direction. Despite building currency reserves the BRICS still feel what is
looming will leave them potentially exposed. As the lead BRICS member, China
will inject $41 billion into the planned
'Firewall' Fund' and each of Brazil, India and Russia will ante $18 billion,
with South Africa paying the remaining $5 billion.
Additionally, urgent side meetings were held separately
to finalize the BRICS-led New Development Bank. Negotiated were its
capital structure, membership, shareholding and governance. It was leaked
that the bank will have an initial subscribed capital of $50 billion
from the BRICS countries. It would appear there was more urgency to the
above discussions than an escalating G20 focus on the Syrian conflict.
When participating in the main G20 session, it was clear what the BRICS agenda.
There focus was the impact of the US monetary "TAPER" direction and the apparent
US disregard for the global consequences. The BRICS veiled contempt towards
US policy was a direct result that since 2008 they have had to fight the
hot money flows that accompanied multiple US Quantitative Easing programs,
with resulting rise in currencies hurting exports, while FDI artificially
pushing up bond prices, creating overdevelopment and inflation pressures.
Now with the US reversing course the BRICS feel the 'back lash' as money
flees, investment stops, currencies plummet and rates rapidly rise. Moreover,
the BRICS see themselves facing serious economic, social and political problems
which they feel are not of their making. They see themselves facing a 'no
win' decision of:
"Impose capital controls OR let the Fed run
your economy"
Jackson
Hole Summit
When it came to the central discussion at the G20 regarding Syria, is it any
wonder that those most vocal against US intervention were these same countries?
They have lost confidence in American global leadership and policy formulation.
Speaking at a final G20 press conference, Russian President Vladimir Putin said:
"Russia, China, India, Indonesia, Brazil, South Africa and Italy came
against military actions in Syria."
Putin also said:
"he was surprised to see that ever more participants in the summit,
including the leader of India, Brazil, the South African Republic,
and Indonesia were speaking vehemently against a possible military
operation in Syria. Putin cited the words of the South African President,
Jacob Zuma, who said many countries were feeling unprotected against
such actions undertaken by stronger countries."
Speaking on behalf of the BRICS, Chinese Vice-Minister of Finance Zhu Guangyao, said:
"We hope the US will carefully consider its decision to exit its quantitative
easing policy to make more contribution to the global economy"
The Reality of The Economic Data
What is missing from a clear understanding of the frustrations of the emerging
economies and the BRICS is the reality of the economic data. Harvard Professor Ricardo
Hausmann, a former minister of planning of an economically imperiled
Venezuela and a former Chief Economist of the Inter-American Development
Bank, has a unique background which allows him to spell out the economic
realities.
Between 2003 and 2011, GDP in current prices grew by a cumulative 35%
in the United States, and by 32%, 36%, and 49% in Great Britain, Japan,
and Germany, respectively, all measured in US dollars. In the same period,
nominal GDP soared by 348% in Brazil, 346% in China, 331% in Russia,
and 203% in India, also in US dollars.
And it was not just these so-called BRIC countries that boomed. Kazakhstan's
output expanded by more than 500%, while Indonesia, Nigeria, Ethiopia,
Rwanda, Ukraine, Chile, Colombia, Romania, and Vietnam grew by more than
200% each. This means that average sales, measured in US dollars, by
supermarkets, beverage companies, department stores, telecoms, computer
shops, and Chinese motorcycle vendors grew at comparable rates in these
countries. It makes sense for companies to move to where dollar sales
are booming, and for asset managers to put money where GDP growth measured
in dollars is fastest.
One might be inclined to interpret this amazing emerging-market performance
as a consequence of the growth in the amount of real stuff that these
economies produced. But that would be mostly wrong.
Consider Brazil. Only 11% of its China-beating nominal GDP growth between
2003 and 2011 was due to growth in real (inflation-adjusted) output.
The other 89% resulted from 222% growth in dollar prices in that
period, as local-currency prices rose faster than prices in the US and
the exchange rate appreciated.
Some of the prices that increased were those of commodities that Brazil
exports. This was reflected in a 40% gain in the country's terms of trade
(the price of exports relative to imports), which meant that the same
export volumes translated into more dollars.
Russia went through a somewhat similar experience. Real output growth
explains only 12.5% of the increase in the US dollar value of nominal
GDP in 2003-2011, with the rest attributable to the rise in oil prices,
which improved Russia's terms of trade by 125%, and to a 56% real appreciation
of the ruble against the dollar.
By contrast, China's real growth was three times that of Brazil and Russia,
but its terms of trade actually deteriorated by 26%, because its manufactured
exports became cheaper while its commodity imports became more expensive.
The share of real growth in the main emerging countries' nominal US dollar
GDP growth was 20%.
The three phenomena that boost nominal GDP - increases in real output,
a rise in the relative price of exports, and real exchange-rate appreciation
- do not operate independently of one another.
Countries that grow faster tend to experience real exchange-rate appreciation,
a phenomenon known as the Balassa-Samuelson
effect. Countries whose terms of trade improve also tend to grow
faster and undergo real exchange-rate appreciation as domestic spending
of their increased export earnings expands the economy and makes dollars
relatively more abundant (and thus cheaper).
Clearly, all is not as it has appeared around the globe! Consider global growth
has been much of a mirage.
After a relentless 6 quarter recession in the EU and the slowing of their
primary export growth market in China, Emerging Markets are hitting a brick
wall.
"FRAGILE FIVE"
As I have written
about before, Brazil, India, Indonesia, Turkey and South Africa (BIITS)
all have something very important in common, they are all peripherals
to their major markets! Additionally, and maybe not by coincidence they
also all have large Debt-to-GDP ratios and significant negative Current
Accounts.
As Nouriel
Roubini writes:
Many other previously fast-growing emerging-market economies - for example,
Turkey, Argentina, Poland, Hungary, and many in Central and Eastern Europe
- are experiencing a similar slowdown. So, what is ailing the BRICS and other
emerging markets?
OVERHEATING: First, most emerging-market economies were overheating
in 2010-2011, with growth above potential and inflation rising and exceeding
targets. Many of them thus tightened monetary policy in 2011, with consequences
for growth in 2012 that have carried over into this year.
COUPLED ECONOMIES: Second, the idea that emerging-market economies
could fully decouple from economic weakness in advanced economies was
far-fetched: recession in the Eurozone, near-recession in the United
Kingdom and Japan in 2011-2012, and slow economic growth in the United
States were always likely to affect emerging-market performance negatively
- via trade, financial links, and investor confidence. For example, the
ongoing Eurozone downturn has hurt Turkey and emerging-market economies
in Central and Eastern Europe, owing to trade links.
STATE CAPITALISM: Third, most BRICS and a few other emerging markets
have moved toward a variant of state capitalism. This implies a slowdown
in reforms that increase the private sector's productivity and economic
share, together with a greater economic role for state-owned enterprises
(and for state-owned banks in the allocation of credit and savings),
as well as resource nationalism, trade protectionism, import-substitution
industrialization policies, and imposition of capital controls.
This approach may have worked at earlier stages of development and when
the global financial crisis caused private spending to fall; but it is
now distorting economic activity and depressing potential growth. Indeed,
China's slowdown reflects an economic model that is, as former Premier
Wen Jiabao put it, "unstable, unbalanced, uncoordinated, and unsustainable," and
that now is adversely affecting growth in emerging Asia and in commodity-exporting
emerging markets from Asia to Latin America and Africa. The risk that
China will experience a hard landing in the next two years may further
hurt many emerging economies.
COMMODITY SUPER-CYCLE: Fourth, the commodity super-cycle that helped
Brazil, Russia, South Africa, and many other commodity-exporting emerging
markets may be over. Indeed, a boom would be difficult to sustain, given
China's slowdown, higher investment in energy-saving technologies, less
emphasis on capital- and resource-oriented growth models around the world,
and the delayed increase in supply that high prices induced.
"TAPER": The fifth, and most recent, factor is the US Federal Reserve's
signals that it might end its policy of quantitative easing earlier than
expected, and its hints of an eventual exit from zero interest rates,
both of which have caused turbulence in emerging economies' financial
markets. Even before the Fed's signals, emerging-market equities and
commodities had underperformed this year, owing to China's slowdown.
Since then, emerging-market currencies and fixed-income securities (government
and corporate bonds) have taken a hit. The era of cheap or zero-interest
money that led to a wall of liquidity chasing high yields and assets
- equities, bonds, currencies, and commodities - in emerging markets
is drawing to a close.
CURRENT ACCOUNTS: Finally, while many emerging-market economies
tend to run current-account surpluses, a growing number of them - including
Turkey, South Africa, Brazil, and India - are running deficits. And these
deficits are now being financed in riskier ways: more debt than equity;
more short-term debt than long-term debt; more foreign-currency debt
than local-currency debt; and more financing from fickle cross-border
interbank flows.
These countries share other weaknesses as well: excessive fiscal deficits,
above-target inflation, and stability risk (reflected not only in the
recent political turmoil in Brazil and Turkey, but also in South Africa's
labor strife and India's political and electoral uncertainties). The
need to finance the external deficit and to avoid excessive depreciation
(and even higher inflation) calls for raising policy rates or keeping
them on hold at high levels. But monetary tightening would weaken already-slow
growth. Thus, emerging economies with large twin deficits and other macroeconomic
fragilities may experience further downward pressure on their financial
markets and growth rates.
BRICS elements (Brazil , India and SouthAfrica) hit hard.
A disillusioned Sunanda Sen, a former professor at Jawaharlal Nehru
University, New Delhi, recently
wrote the following which reflects the plight of the peripheral BRICS.
Volte-faces, from scenes of apparent stability marked by
high GDP growth and a booming financial sector to a state of flux in
the economy, can completely change the expectations of those who operate
in the market, facing situations with an uncertain future. Possible transformations
as above, were identified by Kindleberger in 1978 as a passage from manias, which
generate positive expectations, to panics, which head toward a
crisis.
While manias help continue a boom in asset markets, they are sustained
by using finance to hedge and even speculate in the asset market, as
Minsky pointed out in 1986. However, asset-markets bubbles generated
in the process eventually turn out to be on shaky ground, especially
when the financial deals rely on short-run speculation rather than on
the prospects of long-term investments in real terms. With asset-price
bubbles continuing for some time under the influence of what Shiller
described in 2009 as irrational exuberance, and also with access
to liquidity in liberalised credit markets, unrealistic expectations
of the future under uncertainty sow the seeds for an unstable order. The
above leads to Ponzi deals, argues Minsky, with the rising liabilities
on outstanding debt no longer met, even with new borrowing, since borrowers
are nearing insolvency.Situations as above trigger panics for
the private agents in the market, who fear possible crisis situations.
These are orchestrated with herd instincts or animal spirits in
the market as held by Keynes in 1936. In the absence of actions to counter
the market forces, a possible crisis finally pulls down what in hindsight
looks like a house of cards!
Indeed, when markets have the freedom to choose the path of reckless short-run
financial investments, with high risks and high returns, the individual's
profit calculus eventually proves wrong in the aggregate, leading to
a path of downturn, not just for the financial market but for the economy
as a whole. This is how manias lead to panics and then
to crisis in an economy.
Conclusion
Like the EU Crisis where the problems started in the peripherals and worked
to the core. The problems of the global peripherals can likewise be anticipated
to work towards the global core of economic growth.
Read the full story in this month's Global
Macro Tipping Points at GordonTLong.com
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