The global economy could be hurt if the withdrawal of funds from emerging markets picks up ahead of an expected reduction in the U.S. Federal Reserve’s monetary stimulus, a Bank of Japan board member said on Thursday.
Yoshihisa Morimoto also signalled that Japan’s government needed to proceed with a planned two-stage hike in the sales tax as part of efforts to fix its tattered finances, or face a severe market backlash.
The former utility executive stuck to the BOJ’s assessment that Japan’s economy was headed for a moderate recovery, but noted headwinds such as geo-political risks in the Middle East and market volatility caused by expectations the Fed could start tapering its bond-buying programme as soon as next month.
“Market participants are withdrawing funds from emerging and resource-rich nations on expectations (of Fed’s tapering) and may continue to do so,” Morimoto said in a speech to business leaders in Morioka, northeastern Japan.
“The global economic recovery remains fragile, so there’s huge uncertainty on how a sharp outflow of funds could affect financial markets and global growth,” he said, in the starkest warning to date by a BOJ official on the potential risk for a bigger capital withdrawal from emerging economies.
The Indian rupee and Turkish lira have both hit record lows against the dollar, the Indonesian rupiah has fallen to four-year lows, and other currencies have fallen sharply as investor sentiment has soured on emerging markets.
This has the makings of a grave policy error: a repeat of the dramatic events in the autumn of 1998 at best; a full-blown debacle and a slide into a second leg of the Long Slump at worst.
Emerging markets are now big enough to drag down the global economy. As Indonesia, India, Ukraine, Brazil, Turkey, Venezuela, South Africa, Russia, Thailand and Kazakhstan try to shore up their currencies, the effect is ricocheting back into the advanced world in higher borrowing costs. Even China felt compelled to sell $20bn of US Treasuries in July.
“They are running down reserves by selling US and European bonds, leading to a self-reinforcing feedback loop,” said Simon Derrick from BNY Mellon.
We are told that emerging markets are more resilient than in past crises because they have $9 trillion of reserves. But any use of that treasure to defend the exchange rate entails monetary tightening, and therefore inflicts a contractionary shock on countries already in trouble.
We are also told that they borrow in their own currencies these days, immune to the sort of dollar squeeze that caused such havoc in the early 1980s and the mid-1990s. This is true, but double-edged. India, Brazil and others will surely be tempted to stop fighting markets, let their currencies slide and inflict the pain on foreigners – that is to say, on your pension fund.
If SocGen is right in its just released oil price forecast in a “Syrian war world”, then the global economy is about to undergo an apoplectic shock the likes of which have not been seen since the summer of 2008, when Lehman brothers had to be taken under to generate the deflationary shock sending crude from $130 to $30 in the matter of days. The French bank’s forecast in a nutshell: “Base case scenario: $125 for Brent. We believe that in the coming days, Brent could gain another $5-10, surging to $120-$125, either in anticipation of the attack or in reaction to the headlines that an attack had started. In our base case, we assume an attack begins in the next week. Upside scenario: $150 for Brent If the regional spill over results in a significant supply disruption in Iraq or elsewhere (from 0.5 – 2.0 Mb/d), Brent could spike briefly to $150.” And if indeed 2008 is coming back with a vengeance, the next question is who will be this year’s unlucky Lehman Brothers?
Send lawyers, guns, and money: what does Syria mean for the oil markets?
As the fifth anniversary of the disorderly collapse of the investment bank Lehman Brothers approaches, some analysts will revisit the causes of an historic global “sudden stop” that resulted in enormous economic and financial disruptions. Others will describe the consequences of an event that continues to produce considerable human suffering. And some will share personal experiences of a terrifying time for the global economy and for them personally (as policymakers, financial-market participants, and in their everyday lives).
As interesting as these contributions will be, I hope that we will also see another genre: analyses of the previously unthinkable outcomes that have become reality – with profound implications for current and future generations – and that our systems of governance have yet to address properly. With this in mind, let me offer four.
The first such outcome, and by far the most consequential, is the continuing difficulty that Western economies face in generating robust economic growth and sufficient job creation. Notwithstanding the initial sharp drop in GDP in the last quarter of 2008 and the first quarter of 2009, too many Western economies have yet to rebound properly, let alone sustain growth rates that would make up fully for lost jobs and income. More generally, only a few have decisively overcome the trifecta of maladies that the crisis exposed: inadequate and unbalanced aggregate demand, insufficient structural resilience and agility, and persistent debt overhangs.
The global economy could be in the early stages of another crisis. Once again, the US Federal Reserve is in the eye of the storm.
As the Fed attempts to exit from so-called quantitative easing (QE) – its unprecedented policy of massive purchases of long-term assets – many high-flying emerging economies suddenly find themselves in a vise. Currency and stock markets in India and Indonesia are plunging, with collateral damage evident in Brazil, South Africa, and Turkey.
The Fed insists that it is blameless – the same absurd position that it took in the aftermath of the Great Crisis of 2008-2009, when it maintained that its excessive monetary accommodation had nothing to do with the property and credit bubbles that nearly pushed the world into the abyss. It remains steeped in denial: Were it not for the interest-rate suppression that QE has imposed on developed countries since 2009, the search for yield would not have flooded emerging economies with short-term “hot” money.
The $9 trillion (£5.8 trillion) accumulation of foreign bonds by the rising powers of Asia, Latin America and the emerging world risks going into reverse as one country after another is forced to liquidate holdings to shore up its currency, threatening to inflict a credit shock on the global economy.
India’s rupee and Turkey’s lira both crashed to record lows on Thursday following the US Federal Reserve releasing minutes which signalled a wind-down of quantitative easing as soon as next month.
Dilma Rousseff, Brazil’s president, held an emergency meeting on Thursday with her top economic officials to halt the real’s slide after it hit a five-year low against the dollar. The central bank chief, Alexandre Tombini, cancelled his trip to the Fed’s Jackson Hole conclave in order “to monitor market activity” amid reports Brazil is preparing direct intervention to stem capital flight.
The country has so far relied on futures contracts to defend the real – disguising the erosion of Brazil’s $374bn reserves – but this has failed to deter speculators. “They are moving currency intervention off balance sheet, but the net position is deteriorating all the time,” said Danske Bank’s Lars Christensen.
A string of countries have been burning foreign reserves to defend exchange rates, with holdings down 8pc in Ecuador, 6pc in Kazakhstan and Kuwait, and 5.5pc in Indonesia in July alone. Turkey’s reserves have dropped 15pc this year.
“Emerging markets are in the eye of the storm,” said Stephen Jen at SLJ Macro Partners. “Their currencies are in grave danger. These things always overshoot.”
India’s financial woes are rapidly approaching the critical stage. The rupee has depreciated by 44% in the past two years and hit a record low against the US dollar on Monday. The stock market is plunging, bond yields are nudging 10% and capital is flooding out of the country.
In a sense, this is a classic case of deja vu, a revisiting of the Asian crisis of 1997-98 that acted as an unheeded warning sign of what was in store for the global economy a decade later. An emerging economy exhibiting strong growth attracts the attention of foreign investors. Inward investment comes in together with hot money flows that circumvent capital controls. Capital inflows push up the exchange rate, making imports cheaper and exports dearer. The trade deficit balloons, growth slows, deep-seated structural flaws become more prominent and the hot money leaves.
The trigger for the run on the rupee has been the news from Washington that the Federal Reserve is considering scaling back – “tapering” – its bond-buying stimulus programme from next month. This has consequences for all emerging market economies: firstly, there is the fear that a reduced stimulus will mean weaker growth in the US, with a knock-on impact on exports from the developing world. Secondly, high-yielding currencies such as the rupee have benefited from a search for yield on the part of global investors. If policy is going to be tightened in the US, then the dollar becomes more attractive and the rupee less so.
Iron ore prices have rallied to a three-month high amid increasingly bullish sentiment in China.
Benchmark Australian iron ore, with 62 per cent iron content, rose to $133.10 a tonne on Wednesday, the highest since April, according to The Steel Index, a price reporting agency. The steelmaking raw material has rallied 20 per cent since the start of June, defying pessimism in the broader investment community about the outlook for China’s economy.
China is the largest consumer of iron ore, accounting for some 60 per cent of the global seaborne market. The country’s construction boom triggered record prices for the commodity, which surged to a peak of close to $200 a tonne.
But as the Chinese economy cools and miners’ investments begin to raise supply, many traders and investors expect prices to fall significantly.
However, the market has remained supported at historically high levels this year, despite growing concerns about the outlook for China. Wednesday’s three-month high of $133.10, while down from 2011’s record high, is still more than three times 2007 prices.
The cost of iron ore is crucial for the global economy as it feeds through into the price of steel and therefore everyday goods such as cars and washing-machines. It is also critical for the profitability of two of the world’s largest heavy industries: mining and steelmaking. Major miners such as BHP Billiton, Vale and Rio Tinto have benefited from the strength in iron ore prices – especially as other commodities such as coal and aluminium are weak – even as steelmakers suffer.
European stock markets have closed sharply higher. The stream of decent news from the world’s manufacturing sectors, in the UK, US and across the eurozone, sent all the major indices up today on hopes that the global economy strengthened last month. • FTSE 100: up 60 points at 6681, +0.9% • German DAX: up 117 points at 8393, +1. • French CAC: up 42 points at 4035, +1.07% • Spanish IBEX: up 106 points at 8540, + 1.2% • Italian FTSE MIB: up 336 points at 16818, +2%
The demise of Britain’s leading website for oil dissidents has been seized on by critics as an admission that peak oil is just another malthusian myth like so many before. It comes amid a spate of reports from global banks announcing the death of the commodity supercycle, slain by creative technology and a surge of new supply.
Yet if you stand back, it is hardly evident that the world is again enjoying abundant sources of cheap energy, metals or indeed food. Commodity prices have held up remarkably well given that we are in a global trade depression, albeit one contained by monetary stimulus.
The eurozone is in the longest unbroken recession since the 1930s, with industrial production 13pc below the pre-Lehman peak. Average growth in the US has been 1.1pc over the past three quarters as it grapples with the most drastic fiscal tightening since demobilisation after the Korean War. The Economic Cycle Research Institute continues to insist that the US is in recession right now, a claim less absurd than it sounds.
Russia and Brazil have ground to a near halt. China is in its second “mini-recession” in two years, its growth rate near zero on a GDP deflator basis. China’s oil imports were down 1.4pc in June from a year earlier. Imports of iron ore were down 9.1pc.