Excerpted from the upcoming October Global Macro Tipping Points at GordonTLong.com
Shock waves are washing ashore across Asia and the emerging markets and
have already destabilized sovereign capital flows. It is eerily reminiscent
of the Asian Crisis of 1997. Many are quick to point out that this time it is
different because.... These are words that always cost investors the most!
The Euro Crisis started in the peripheral countries (PIIGS) and eventually
spread to the EU core. A potential global crisis has begun in the
"FAULTY FIVE" peripheral countries (BIITS) and has already spread
to the global core as currency reserves, often held in US Treasuries, are
sold (forcing up global yields) to fight falling currencies, rising interest
rates and capital flight.
Yes it may be different this time with better abilities to absorb the
shock waves. A combination of flexible exchange rates, strong international
reserves, better monetary regimes, and a shift away from foreign-currency
debt are certainly helping. However, years of political paralysis and postponed
structural reforms in the BIITS have created serious destabilizing
vulnerabilities.
"Faulty Five"
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.
BRICS elements (Brazil , India and SouthAfrica) hit hard!
Being a peripheral does not mean causation, but it does mean additional
time and cost. When money and credit tightens, time and cost matter. Labor
arbitrage can surmount this differential but it is removed when pricing
pressures mount and those higher on the value-add ladder have more pricing
power.
Debt Matters
Sovereign Debt doesn't matter, until in matters.
It matters when current accounts go negative.
Large current-account deficits are a problem as are real exchange rate
appreciations. These are well understood as key macro predictors. Going
forward expect net external debt to additionally become more critical.
Watch for Japan to teach us this lesson as the shock waves echo back
towards the core.
According to economic theory, the major determinants of capital flows to
emerging-market economies are:
- Real growth-rate
differentials,
- Interest-rate
differentials, and
- Global risk aversion.
All of these have changed negatively since the talk of "TAPER"
began.
The Internet may be making the world smaller,
Globalization may be removing borders,
But sometimes distance simplymatters!
Remember, culture differences still vary by distance.
Read the full story in this month's Global Macro Tipping
Points at GordonTLong.com
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