Is a New Economic Crisis at Hand?

Cross-posted from The Star (Malaysia)

AT the end of last week, several developing countries saw sharp falls in their currency as well as stock market values, prompting the question of whether it is the start of a wider economic crisis.

The sell-off in emerging economies also spilled over to the American and European stock markets, thus causing global turmoil.

Malaysia was not among the most badly affected, but the ringgit also declined in line with the trend by 1.1% against the US dollar last week; it has fallen 1.7% so far this year.

An American market analyst termed it an “emerging market flu”, and several global media reports tend to focus on weaknesses in individual developing countries.

However, the across-the-board sell-off is a general response to the “tapering” of purchase of bonds by the US Federal Reserve, marking the slowdown of its easy-money policy that has been pumping billions of dollars into the banking system.

A lot of that was moved by investors into the emerging economies in search of higher yields. Now that the party is over (or at least winding down), the massive inflows of funds are slowing down or even stopping in some developing countries.

The current “emerging markets sell-off” is thus not explained by ad hoc events. It is a predictable and even inevitable part of a boom-bust cycle in capital flows to and from the developing countries, coming from the monetary policies of developed countries and the investment behaviour of their investment funds.

This cycle, which is very destabilising to the developing economies, has been facilitated by the deregulation of financial markets and the liberalisation of capital flows, which in the past was carefully regulated.

This prompted bouts of speculative international flows by investment funds. Emerging economies, having higher economic growth and interest rates, attracted investors.

Yilmaz Akyuz, chief economist at South Centre, analysed the most recent boom-bust cycles in his paper Waving or Drowning?

A boom of private capital flows to developing countries began in the early 2000 but ended with the flight to safety triggered by the Lehman collapse in September 2008.

The flows recovered quickly. By 2010-12, net flows to Asia and Latin America exceeded the peaks reached before the crisis. This was largely due to the easy-money policies and near zero interest rates in the United States and Europe.

In the United States, the Fed pumped US$85bil (RM283bil) a month into the banking system by buying bonds. It was hoped the banks would lend this to businesses to generate recovery, but investors placed much of the funds in stock markets and developing countries.

The surge in capital inflows led to a strong recovery in currency, equity and bond markets of major developing countries. Some of these countries welcomed the new capital inflows and boom in asset prices.

Others were angry that the inflows caused their currencies to appreciate (making their exports less competitive) and that the ultra-easy monetary policies of developed countries were part of a “currency war” to make the latter more competitive.

In 2013, capital inflows into developing countries weakened due to the European crisis and the prospect of the US Fed “tapering” or reducing its monthly bond purchases.

This weakening took place just as many of the emerging economies saw their current account deficits widen. Thus, their need for foreign capital increased just as inflows became weaker and unstable.

In May to June 2013, the Fed announced it could soon start “tapering”. This led to sudden sharp currency falls, including in India and Indonesia.

However, the Fed postponed the taper, giving some breathing space. In December, it finally announced the tapering — a reduction of its monthly bond purchase from US$85bil (RM283bil) to US$75bil (RM249bil), with more to come.

There was then no sudden sell-off in emerging economies, as the markets had already anticipated it and the Fed also announced that interest rates would be kept at current low levels until the end of 2015.

By now, however, the investment mood had already turned against the emerging economies. Many were now termed “fragile”, especially those with current account deficits and dependent on capital inflows.

Most of the so-called Fragile Five are in fact members of the BRICS, which had been viewed just a few years before as the most influential global growth drivers.

Several factors emerged last week, which together constituted a trigger for the sell-off. These were a “flash” report indicating contraction of manufacturing in China; a sudden fall in the Argentini­an peso; and expectations that a US Fed meeting on Jan 29 will announce another instalment of tapering.

For two days (Jan 23 and 24), the currencies and stock markets of several developing countries were in turmoil, which spilled over to the US and European stock markets.

If this situation continues this week, it may just signal a new phase of investor disenchantment with emerging economies, reduced capital inflows or even outflows. This could put strains on the affected countries’ foreign reserves and weaken their balance of payments.

The accompanying fall in currency would have positive effects on export competitiveness, but negative effects on accelerating inflation (as import prices go up) and debt servicing (as more local currency is needed to repay the same amount of debt denominated in foreign currency).

This week will thus be critical in seeing whether the situation deteriorates or stabilises, which may just happen if the Fed decides to discontinue tapering for now. Unfortunate­ly, the former is more likely.

Triple Crisis welcomes your comments. Please share your thoughts below.

7 Responses to “Is a New Economic Crisis at Hand?”

  1. […] TripleCrisis This entry was posted in Survive Food Crisis and tagged crisis, Economic, Hand. Bookmark the permalink. ← Global Dollar-Based Financial Fragility in the 2000s, Part 1 […]

  2. […] Is a New Economic Crisis at Hand?n Triple Crisis […]

  3. thanks says:

    Thank you for this excellent overview of the EM situation. Very well written.

  4. Chris Hall says:

    Sent from my iPhone

    Begin forwarded message:

    Date: January 29, 2014 at 1:14:55 PM PST
    To: “”
    Subject: Re: Bloomberg comment 1-29-14

    Mr. Torres

    I hope you understand that the current fiat money system is a debt money system. A debt money system is an unstable monetary system. Too much debt can create financial crisis. There is a way to make our money more stable.

    The problem with fiat money is that it is almost impossible to control the private sector banking system from creating too much money (debt). The current system of raising, and lowering interest rates has not been effective in controlling rising prices. The Federal Reserve inflation target is 2%. In the last 50 years prices have risen 1000%. If the Fed’s monetary policies were effective, a 2% rise in prices in a 50 year period would have produced price increases of 100%. The Fed has missed their 2% target by 900%. These results can only lead to the conclusion that their monetary tool of raising and lowering of interest rates is ineffective in controlling the amount of money (debt) being created.

    So what “tool” would be effective in controlling the amount of money (debt) the private financial sector creates. We know that in a debt money system to create money somebody has to go into debt. Problems begin to occur when too many people want to go into debt, which creates too much money, creating inflation, and instability in the financial sector.

    So what encourages people to create too much money (debt)? The answer is the income tax. The interest deduction, the lower long term capital gains rate, and the tax on interest earned on money investments all work to create the “animal sprites” that John Maynard Keynes, the British economist, wrote about. These tax polices are needed to increase economic activity when the economy is in the recession cycle. The solution high inflation/appreciation rates is to automatically neutralize these tax policies as the economy recovers, and before the “animal sprits” are created.

    We need to enact the “2% Appreciation/inflation Taxation Policy” Please go to Please read the third article “Tax Policy Changes Needed Before The Fed Changes Monetary Policy For Stable Interest Rates”

  5. Chris Hall says:

    Please remove my email address and other information above my comment before posting. It was mistakenly posted. Thank you Chris Hall

  6. […] 3%, after the U.S. Federal Reserve said it would scale back further on its stimulus measures…Is A New Economic Crisis At Hand?  TripleCrisis   …AT the end of last week, several developing countries saw sharp […]

  7. […] Elsewhere: Is a New Economic Crisis at Hand, Triple Crisis Rahul, Modi, Kejriwal all underplay how rising inequality threatens India’s […]