August 22, 2013, 12:46 p.m. ET

Ben Bernanke's Global Adventure

The markets show unwinding QE is not so easy.

U.S. Federal Reserve Chairman Ben Bernanke

For a sign of the topsy-turvy world the Federal Reserve has created, look no further than the past week's global market ructions. Stock markets in Asia in particular spent most of this week in free-fall. The Indian rupee and Indonesian rupiah have plunged in value as capital floods out of both countries. Thailand and Malaysia may be next, thanks to their unfavorable trade balances and mounting debt worries.
All of this is because of good news in the U.S., traditionally Asia's largest export market whose purchases from Asian factories have driven regional growth for decades. Investors and businesses in Asia are afraid that signs of economic improvement in Americasuch as those signs are—could prompt the Fed to dial back the easy money policy it has maintained since the financial panic.
Only some surprisingly optimistic numbers Thursday from HSBC's HSBA.LN +0.71% forward-looking China barometer, the Purchasing Managers Index, partly stemmed the market rout. The release of the Fed's July minutes on Wednesday seemed to confirm that a bond-buying "taper" is on the way, but the fact that markets often front-run the news gives hope that this bout of volatility will subside for now.
In the longer term, however, the reallocation of capital away from emerging markets is expected to continue. Rising yields in the U.S. are attracting back capital that had fled elsewhere in search of higher rates of return. For now, that means potentially destabilizing capital outflows from economies that had benefited from investors' unusual willingness to take on higher risks for at best modest returns.
That could mean higher funding costs again become a fact of life for Asian and emerging-market governments and businesses. While this will be painful, it could also bring benefits. The re-emergence of America as a preferred investment destination will ease capital inflows that sparked both unsustainable currency appreciations and inflation and asset-price bubbles in Asia. A dose of capital scarcity might also focus developing-economy minds on truly productive investments, no small matter in countries prone to waste and corruption in the best of times but especially when money is cheap.
This week's turmoil nonetheless shows that it's a rocky road from here to there, and the market tribulations should be on American policy makers' minds. Monetary optimists have argued that, when the time comes, the Fed will be able to taper its easy money relatively smoothly. Perhaps, but a global repricing of risk in line with changing rates in America will also unsettle the very economies to which American companies increasingly turn for revenue growth.
Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

Emerging market rout threatens wider global economy

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.

By Ambrose Evans-Pritchard

8:38PM BST 22 Aug 2013

A Pakistani money exchange dealer displays foreign currency notes at his roadside stall in Karachi
Fears of Fed tightening have pushed borrowing costs worldwide to levels that could threaten global recovery Photo: AFP

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 realdisguising 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.”
It was Fed tightening and a rising dollar that set off Latin America’s crisis in the early 1980s and East Asia’s crisis in the mid-1990s. Both episodes were contained, though not easily.

Emerging markets have stronger shock absorbers today and largely borrow in their own currencies, making them less vulnerable to a dollar squeeze. However, they now make up half the world economy and are big enough to set off a crisis in the West.

Fears of Fed tightening have pushed borrowing costs worldwide to levels that could threaten global recovery. Yields on 10-year bonds jumped 47 basis points to 12.29pc in Brazil on Thursday, 33 points to 9.72pc in Turkey, and 12 points to 8.4pc in South Africa.

There had been hopes that the Fed might delay its tapering of bond purchases, chastened by the jump in long-term rates in the US itself. Ten-year US yields – the world’s benchmark price of money – have soared from 1.6pc to 2.9pc since early May.

Hans Redeker from Morgan Stanley said a “negative feedback loop” is taking hold as emerging markets are forced to impose austerity and sell reserves to shore up their currencies, the exact opposite of what happened over the past decade as they built up a vast war chest of US and European bonds.

The effect of the reserve build-up by China and others was to compress global bond yields, leading to property bubbles and equity booms in the West. The reversal of this process could be painful.

China sold $20bn of US Treasuries in June and others are doing the same thing. We think this is driving up US yields, and German yields are rising even faster,” said Mr Redeker. “This has major implications for the world. The US may be strong to enough to withstand higher rates, but we are not sure about Europe. Our worry is that a sell-off in reserves may push rates to levels that are unjustified for the global economy as a whole, if it has not happened already.”

Sovereign bond strategist Nicolas Spiro said India is “caught between the Scylla of faltering growth and the Charybdis of currency depreciation” as hostile markets start to pick off any country with a large current account deficit. He said India’s central bank is playing with fire by reversing its tightening measures to fend off recession. It has instead set off a full-blown currency crisis that is crippling for companies with dollar debts.

India is not alone. A string of countries across the world are grappling with variants of the same problem, forced to pick their poison.

22, 2013 1:48 pm
Now the Brics party is over, they must wind down the state’s role
Nations did not take advantage of the good years to improve their economies, says Anders Aslund
After a decade of infatuation, investors have suddenly turned their backs on emerging markets. In the Bric countriesBrazil, Russia, India and China growth rates have quickly fallen and current account balances have deteriorated. The surprise is not that the romance is over but that it could have lasted for so long.
From 2000 to 2008 the world went through one of the greatest commodity and credit booms of all times. Genesis warns that after seven years of plenty, “seven years of famine will come ... and the famine will ravage the land”. Perhaps the combined commodity and credit cycle, from which the Bric countries have benefited more than their due, is divinely appointed.
The boom was prolonged for half a decade by quantitative easing in mature economies, flooding them with cheap financing. During their years of plenty, the Brics did not have to make hard choices. Today, their entrenched elites seem neither inclined to nor able to do so. Their lives have been too good.
Now the booms are over. Brazil and Russia have been hit by the levelling out of commodity prices, which are expected to decline for several years. Those two countries may also be caught in the middle-incometrap. Recent research has also found that countries tend to experience a sharp growth slowdown when gross domestic product per capita reaches about $15,000.
While the Brics have accumulated large foreign reserves, they did not take advantage of the good years to improve the underlying state of their economies. China’s banks are overleveraged and India suffers from most economic ailments. Its inflation is too high; its budget deficit, public debt and current account deficit are too large. Governance is mediocre at best, reflecting substantial corruption and poor business environments.
The World Bank compiles its ease of doing business index for 185 countries. The Brics do even worse by this measure, with China ranking 91, Russia 112, Brazil 130 and India 132. Russia has set the long-term goal of rising 100 steps but so far has done little to accomplish it. China, meanwhile, is lobbying the World Bank to abolish this index.
One can see the hubris of the boom in the construction of white elephants; Olympic Games tell it all. In 2008 Beijing beat all prior games with an expenditure of $40bn. Russia is expending $51bn on the 2014 Sochi Winter Olympics compared with $6bn spent on Vancouver’s in 2010. Brazil’s recent protests were, in part, about the cost of the 2014 football World Cup and 2016 Olympics.
When it comes to vital infrastructure investment, however, Brazil, India and Russia invest too little, leading to multiple bottlenecks. Russia has not expanded its paved road network since 1994. Only in 2018 is a highway finally expected to connect Moscow to St Petersburg – and only then because it will be Russia’s turn hosting the World Cup.

Worse, the current Bric thinking goes in the wrong direction. All have large state sectors and are relatively protectionist. Because of their recent economic successes and the western financial crisis, their policy makers increasingly see state capitalism as the solution, and private enterprise and free markets as problems. Especially in Russia and Brazil, influential circles call for a greater role of the state, although the corrupt state is their key problem.

Last month Igor Rudensky, the United Russia parliamentarian who chairs the State Duma’s committee on economic policy, even stated: “The leading role and the commanding heights in the economy should belong to state corporations ... We have to preserve all the positive from [the Soviet] historical experience.” Back to the future!

Even if the Bric political leaders were to face up to reality, their giant state corporations rule the roost. They hold an iron grip over energy, transport and banking. But the Brics do not rule the world. Because of them the west has played down the World Trade Organization, instead seeking regional trade agreements among like-minded countries such as the Transatlantic Trade and Investment Partnership between the US and Europe and the Trans-Pacific Partnership with most states but China around the Pacific Rim.
The Brics party is over. Their ability to get going again rests on their ability to carry through reforms in grim times for which they lacked the courage in a boom.

The writer is a senior fellow at the Peterson Institute for International Economics

Copyright The Financial Times Limited 2013.

22, 2013 8:53 pm

Emerging markets endure wild rollercoaster ride
Thursday was another day of turmoil for emerging markets.
Unimpressed by the Turkish central bank’s recent efforts to support its currency, investors sent the lira down to a record low against the US dollar; India’s rupee fell to its lowest-ever level; Indonesia’s rupiah dropped to the weakest since 2009.

Central bank reserves

As if that were not enough, Malaysia’s ringgit and Thailand’s baht ended the day in a three-year trough.
Many central banks have sought to reverse or at least slow the declines by using foreign currency reserves to intervene in the markets. Morgan Stanley estimates that central banks in the developing world, excluding China, lost about 2 per cent of their reserves between May and July.
The decline in reserves is driven both by simple outflows of foreign capital and by market interventions.
The US Federal Res­erve’s plan to reduce its monetary stimulus has spooked investors and driven many to pull money out of the developing world, sending most emerging market currencies tumbling.
Although reserves are held precisely for these sorts of squalls, the pace and extent of the declines have been particularly eye-catching in some countries.
Indonesia has lost 13.6 per cent of central bank reserves, Turkey 12.7 per cent and Ukraine almost 10 per cent. But India and Brazil, two other countries with struggling currencies, have lost a more moderate 5.5 and 1.8 per cent respectively.
While depreciating currencies make exports cheaper, they also fuel inflation by increasing the cost of imports. And many emerging market companies, governments and households have loans denominated in dollars or other foreign currencies that become pricier to pay off if the domestic currency is in the doldrums.
While most emerging markets no longer have heavily managed or pegged exchange rates, central banks nonetheless occasionally intervene in currency markets to prevent depreciations or appreciations becoming too volatile.
But the overall decline in reserves stands in sharp contrast to a long trend of healthy and climbing financial firepower in the developing world, driven both by trade surpluses and prudence following past crises in the 1980s and 1990s.
A series of financial calamities triggered a seismic shift in thinking among emerging market policy makers: higher reserves to prevent any more humiliating western bailouts.
The accumulation of reserves has gathered pace since the start of the financial turmoil, when capital inflows into emerging markets swelled because of western monetary stimulus and investor aversion to the stricken advancedeconomies. By the end of the first quarter of 2013, emerging market central banks held $7.4tn of foreign currency reserves, according to International Monetary Fund Cofer data.
While this trend is reversing, emerging market veterans point out that central banks’ war chests are still much larger than they have been in past crises. Exchange rates are now for the most part flexible, and governments no longer rely as much on foreign funding.
All these structural improvements should serve emerging markets well in a less easy monetary policy environment. However, not all countries have accumulated reserves at the same pace. China and the oil-rich Gulf states represent a large chunk of the IMF’s estimates. Even relatively high reserves can be quickly depleted if a country has a large current account deficit.
While most developing country governments have weaned themselves off an addiction to foreign currency-denominated loans, many companies have gone on a dollar borrowing splurge. Many investors still see this as a big vulnerability. For that reason, investors expect many central banks to step away from direct currency market interventions and attempt to stanch outflows through interest rate increases. That may hurt growth, but many countries may have no choice.

U.S. Economy

Brace Yourself: This is What the Fed’s QE Has Done for Our Economy

By Tara Clarke, Associate Editor, Money Morning

August 21, 2013


The Fed's QE (quantitative easing) program has created multiple trillions of dollars since it first started in 2008.
But now there are signs the QE policy will finally come to a close.

On June 19, Federal Reserve Chairman Ben Bernanke announced the Fed may start to taper its QE by the end of the year if it met an unemployment target of 7%, while keeping a targeted inflation rate at 2%.
Indeed, today's (Wednesday) Fed minutes reflect that policymakers are forming a plan to taper the stimulus sometime this year and plan for a full stop come mid-2014.

At the outset, the Fed hoped to stimulate a stagnant U.S. economy by increasing the money supply. And now, five years later, some mainstream media would have you think the economy is in decent shape...

A recent Associated Press article described the U.S. economy as "growing at a steady pace." Other analysts feel the economy is stable and a long shot from the 1970s, when the Fed churned out cash on a much smaller scale, which led to damaging rates of inflation.

But the truth is the economy only appears stable.

Beneath the surface, the Fed is roiling, building up to a breakdown that could be worse than 2008's subprime/solvency crisis.

Much like prodding a sick child, the symptoms of economic bad health are there, even if you can't see them at first glance.

Take U.S. car inventories, for example...
3.27 million new cars are presently glutting up dealerships across the U.S. - a greater excess than has been seen in nearly five years.

In fact, that's enough automobiles to equip every man, woman, and child in the state of Iowa, and nearly enough to equal the number of iPhones added to Verizon's network last quarter.

Last year, there were 2.7 million fewer vehicles in the nation's car inventory; back in 2011 it was a million fewer than that.

With 70% of the economy powered by consumer spending, the indications that auto consumers aren't spending is a danger sign.

And the retail sector continues to show mixed results that suggest consumer spending isn't rising to levels needed for a healthy economy.

When paired with another measure of economic health, this glut could very well feed into a scary cycle that will put a major drag on the economy - all this despite the Fed's attempts to goose activity with QE...

The Car Glut Will Affect Unemployment

Even though the unemployment rate fell to 7.4% in July - the lowest rate since December 2008 - U.S. joblessness is still a huge concern.

A significant part of the drop is due to discouraged workers exiting the labor force. Overall the labor force dropped by 37,000 in July, marking a 35-year low in the percentage of working-age Americans looking for jobs.

Moreover, the number of temporary workers who want full-time jobs continues to increase, as the below chart illustrates:

The Fed's QE program is supposed to stimulate the creation of high-paying, full-time jobs, but instead, we're getting a lot of part-time jobs: through the first seven months of 2013, 953,000 jobs have been created; a full 731,000 of those, or 77%, have been part-time.
In sum, over 4 million people have been out of work for more than six months, and a doleful 11.5 million are looking for work in total.

22.1 million Americans are either unemployed or underemployed.
And numbers like the car inventory glut show us joblessness is about to get worse...
Come September, most 2014 models will hit the market. The excess cars will have to be sold at big discounts. Automakers will also cut back on production to deal with the glut.
This means lower profits, which translate to lower share prices.
And because automakers are part of a grand supply chain - from plants that assemble cars to parts-makers and suppliers - lower profits and share prices will also affect other sensitive businesses.

For instance, during 2008's economic downturn, suppliers were forced to consolidate operations. They closed plants, laid off workers, and reduced capacity by as much as 30%.
A squeeze on the auto supply chain, joblessness, and a dissatisfied work force are all factors lining up to drag down the U.S. economy.
On top of that, Bernanke's signal of the end of QE starting in 2013 has had an immediate effect on interest rates, driving them higher. Borrowing costs will rise in turn.
This will slow the economy even further.
So what has the Fed's QE done for the economy? It's placed Americans at great risk.
Meanwhile, Bernanke's printing presses are still running...for now.