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The Curious Case of Missing Defaults

November 1, 2017

CAMBRIDGE – Booms and busts in international capital flows and commodity prices, as well as the vagaries of international interest rates, have long been associated with economic crises, especially – but not exclusively – in emerging markets. The “type” of crisis varies by time and place. Sometimes the “sudden stop” in capital inflows sparks a currency crash, sometimes a banking crisis, and quite often a sovereign default. Twin and triple crises are not uncommon.

Rising international interest rates have usually been bad news for countries where the government and/or the private sector rely on external borrowing. But for many emerging markets, external conditions began to worsen around 2012, when China’s growth slowed, commodity prices plummeted, and capital flows dried up – developments that sparked a spate of currency crashes spanning nearly every region.

In my recent work with Vincent Reinhart and Christoph Trebesch, I show that over the past two centuries, this “double bust” (in commodities and capital flows) has led to a spike in sovereign defaults, usually with a lag of 1-3 years. Yet, since the peak in commodity prices and global capital flows around 2011, the incidence of sovereign defaults worldwide has risen only modestly.

…click on the above link to read the rest of the article…

Why One Trader Thinks The Turkish Crash Will Lead To EM Contagion

October 9, 2017

Why One Trader Thinks The Turkish Crash Will Lead To EM Contagion

Yesterday when we discussed the dramatic crash in the Turkish lira, resulting from the visa suspension drama at both Turkish and US consulates, we noted that “this is the currency’s seventh consecutive decline, after dropping on Friday amid concern Fed tightening would hurt EM currencies, and should it persist may finally have an adverse impact on other EM currencies, not to mention various other local Turkish asset classes when markets reopen in a few hours.”

Well, it’s now a few hours later, and as expected the selloff has spread, with the Borsa Istanbul 100 Index dropping as much as 4.7% to the lowest since June 21: the selloff was the biggest one-day drop since the “failed coup” of July 18, 2016; with the index breaking below 100-DMA, and now in a correction, down 10% since peak in late August. Among biggest decliners on Monday are Turkish Airlines, down 8%; Karsan Otomotiv (-8.9%), Zorlu Enerji (-8.4%), Dogan Sirketler Grubu (-8.3%)

As for the Lira, it continued sliding and at one point the session drop was a large as 8%.

But more importantly, overnight the risk of EM contagion stemming from the Turkish crash was also the topic of the latest note from Mark Cudmore – Bloomberg’s versatile FX and macro strategist – who just like us, believes that unless the TRY crash is stabilized, it could lead to a broader EM rout. As Cudmore notes, “International investors have been gobbling up Turkish debt this year. Those positions were beginning to look vulnerable as the lira led the broad emerging-market FX correction that started almost a month ago. Such investments became more vulnerable last week, when Turkish inflation data confirmed prices are spiraling out of control and real yields in the country are too low. The move toward the exit by bond holders may soon become a stampede.”

…click on the above link to read the rest of the article…

In Emerging Markets, It’s Time To Dump Most Central Banks, And Their Currencies Too

May 23, 2017

In Emerging Markets, It’s Time To Dump Most Central Banks, And Their Currencies Too

On March 16th, the New York Times carried reportage by Peter S. Goodman, Keith Bradsher and Neil Gough, which was titled “The Fed Acts. Workers in Mexico and Merchants in Malaysia Suffer.” The theme of their extensive reportage is that U.S. monetary policy is the elephant in the room. It is the elephant that swings exchange rates and capital flows to and fro in emerging-market countries, causing considerable pain.

The real problem that all of the countries mentioned in the New York Times reportage face is the fact that they have central banks that issue half-baked local currencies. Although widespread today, central banks are relatively new institutional arrangements. In 1900, there were only 18 central banks in the world. By 1940, the number had grown to 40. Today, there are over 150.

Before the rise of central banking the world was dominated by unified currency areas, or blocs, the largest of which was the sterling bloc. As early as 1937, the great Austrian economist Friedrich von Hayek warned that the central banking fad, if it continued, would lead to currency chaos and the spread of banking crises. His forebodings were justified. With the proliferation of central banking and independent local currencies, currency and banking crises have engulfed the international financial system with ever-increasing severity and frequency. What to do?

The obvious answer is for vulnerable emerging-market countries to do away with their central banks and domestic currencies, replacing them with a sound foreign currency. Panama is a prime example of the benefits from employing this type of monetary system. Since 1904, it has used the U.S. dollar as its official currency. Panama’s dollarized economy is, therefore, officially part of the world’s largest currency bloc.

The results of Panama’s dollarized monetary system and internationally integrated banking system have been excellent (see accompanying table).

…click on the above link to read the rest of the article…

“Are We Prepared to Impose Temporary Debt Standstills?”

April 1, 2016

“Are We Prepared to Impose Temporary Debt Standstills?”

In a remarkable turnaround, foreign investors are estimated to have pumped over $35 billion into emerging market (EM) stocks and bonds in March, the highest monthly inflow in nearly two years, according to the Institute of International Finance. One of the biggest beneficiaries is Latin America, which for months had been shunned by investors. The region took in $13.4 billion, with equities in even crisis-hit Brazil receiving over $2 billion.

But is this the beginning of an enduring rally or is this “hot money,” which can change direction without notice, about to get cold feet again?

“Over the past 15 years there has been a very large increase in the presence of foreigners in domestic equity, bond and deposit markets of developing countries,” says Dr. Yilmaz Akyuz, the chief economist of the South Centre, an intergovernmental organization of developing and emerging economies representing 52 countries, including four of the BRICS nations (Russia excluded). Akyuz was speaking at a briefing of delegates at the UN’s Geneva headquarters.

This influx of foreign funds may seem like a blessing until the tide suddenly turns. Then it becomes a curse.

“Your reserves may be adequate to service your short-term debt but if there is a massive exit from domestic bond, equity, and deposit markets then your reserves will not be enough,” Akyuz warns. There’s a simple reason for this: a large chunk of emerging markets’ reserves is derived from the initial entry of hot money into their economy.

Last year, investors pulled $6 billion out of emerging market funds managed by Pimco, according to the New York Times. A debt fund run by MFS investment management in Boston lost $1.4 billion, and Trust Company of the West in Los Angeles suffered outflows of $1.8 billion from its $2.6 billion bond offering last year.

…click on the above link to read the rest of the article…

“Time To Panic”? Nigeria Begs World Bank For Massive Loan As Dollar Reserves Dry Up

January 31, 2016

“Time To Panic”? Nigeria Begs World Bank For Massive Loan As Dollar Reserves Dry Up

Having urged “don’t panic” just 4 short months ago, it appears Nigeria just did just that as the global dollar short squeeze forces the eight-month-old government of President Muhammadu Buhari to beg The World Bank and African Development Bank for $3.5bn in emergency loans to help fund a $15bn deficit in a budget heavy on public spending amid collapsing oil revenues. Just as we warned in December, the dollar shortage has arrived, perhaps now is time to panic after all.

In September, Nigerian central bank Governor Godwin Emefiele ruled out a naira devaluation on Thursday and told people not to panic about a government order which risks draining billions of dollars from the financial system.

In an interview with Reuters, Emefiele said he was ready to inject liquidity if needed into the interbank market, which dried up this week following the directive to government departments to move their funds from commercial banks into a “Treasury Single Account” (TSA) at the central bank.

The policy is part of new President Muhammadu Buhari’s drive to fight corruption, but analysts say it could suck up as much as 10 percent of banking sector deposits in Africa’s biggest economy – playing havoc with banks’ liquidity ratios.

With global oil prices tumbling, banks and companies are already struggling with the consequences of a dive in Nigeria’s energy revenues that has hit the naira currency and triggered flows of capital out of the country.

Then JP Morgan kicked Nigeria out of its influential Emerging Markets Bond Index last week due to restrictions that the central bank imposed on the currency market to support the naira and preserve its foreign exchange reserves.

Since taking office in May, Buhari has vowed to rein in Nigeria’s dependency on oil exports which account for 90 percent of foreign currency earnings.

…click on the above link to read the rest of the article…

Bear Necessities

January 20, 2016

BEAR NECESSITIES

“At first sign of crisis, the ignorant don’t panic because they don’t know what’s going on. Then later they panic precisely because they don’t know what’s going on.”

– Jarod Kintz.

In a crisis, it helps to have good counsel. Investment strategist Mike Tyson is pretty good at summing up the problem:

“Everyone has a plan ‘til they get punched in the mouth.”

Or as the military strategist Helmuth von Moltke the Elder put it, somewhat more formally:

“No battle plan ever survives contact with the enemy.”

The enemy has been quick to show himself this year, in the form of a bear market, at least for stocks. This bear has so far been quick, and indiscriminate: the US; Europe; China; stock markets have fallen sharply, internationally. Investors, being human, have scrabbled in search of an explanatory narrative.

Some have blamed the Fed’s baby steps towards normalising interest rates (if a rise from 0% to 0.25% can cause this much investor concern, get a load of history). Some blame the collapse in the oil price. Last week we watched David Cronenberg’s 2012 thriller ‘Cosmopolis’, which has Robert Pattinson playing a 28-year-old hedge fund billionaire driving around town and losing his entire fortune in a single day due to the unexpected rise of the yuan. Other than getting the direction of the renminbi wrong, it could have been shot yesterday. (The film, like the financial markets of 2016, is largely unfathomable.)

But as CLSA’s Christopher Wood points out, perceptions of emerging markets, including China’s, are becoming increasingly divorced from reality. The oil collapse, for one, is a huge red herring. Asia in aggregate

“is a massive beneficiary of lower oil prices.. [and] Asia now represents 72% of the MSCI Global Emerging Markets Index.”

So the narrative on oil is probably wrong, at least as regards most Asian economies, including Japan’s.

…click on the above link to read the rest of the article…

Soon Comes The Deluge

January 20, 2016

Soon Comes The Deluge

The robo-machines are now having a grand old time hazing the August lows at 1870 on the S&P, and may succeed in ginning up another dead-cat bounce or two. But this market is going down for the count owing to a perfect storm.

To wit, the global and US economies are heading into an extended deflationary recession; S&P earnings peaked at $106 per share more than a year ago and are already at $90, heading much lower; and the central banks of the world are out of dry powder after a 20-year binge of balance sheet expansion.

Global Central Bank Balance Sheet Explosion

The latter is surely the most important of the three. It means there will be no printing press driven reflation of the financial markets this time around. And without more monetary juice it’s just a matter of time before a whole generation of punters and front-runners abandon the casino and head for the hills.

Even with today’s ragged bounce, the broad market has now gone sideways for nearly 700 days. The BTFD meme is loosing its mojo because it only worked so long as the Fed-following herd could point to more printing press cash flowing into the market or promises of “accommodation” that were credible. But that will soon be ancient history.

^SPX data by YCharts

Indeed, it is already evident that “escape velocity” has again escaped. Q4 GDP growth is now running at barely 0.5%, and the current quarter could actually be negative for reasons we will analyze in the days ahead.

But the real economic situation is actually worse than the apparent flatling trend of recent months. As we have long insisted, the GDP does not measure true gains in national wealth or main street living standards.

…click on the above link to read the rest of the article…

Emerging Market Meltdown Sinks Spain’s Biggest Companies

January 10, 2016

Emerging Market Meltdown Sinks Spain’s Biggest Companies

A Lethal Cocktail

After years of uninterrupted domination, the old guard at Spain’s Ibex 35 stock index – two mega-banks Banco Santander and BBVA, oil giant Repsol, telecommunications behemoth Telefonica, and utility Iberdrola – is beginning to lose it.

Today the big-five’s combined capitalization represents 45% of the ibex 35’s total capitalization. This may seem like a ridiculously high percentage for five companies compared to most other stock markets, but it is actually its lowest share in decades. Over the last 15 years, the big five’s combined share has averaged 60% and at times even reached as high as 65%.

There are many reasons for this change, including the rise of relative newcomers. Of particular note is the spectacular growth of Spain’s clothing giant Inditex, whose brands include the world’s biggest fashion retailer, Zara, and whose owner, Amancio Ortega, is now the world’s second richest man. Inditex has a market capitalization of €92.7 billion, compared to Santander’s €59.5 billion!

The other main reason for the big five’s shrinking market share is their sinking share prices. Telefonicá and BBVA’s shares are at their lowest point since 2013. Santander’s shares, which have suffered the debilitating effects of countless capital expansions, haven’t been this low since 2012. As for Repsol, the last time its shares plumbed their current depths was in the 1990s. The only member of the big five to escape this rout is Iberdrola.

One thing that all of these companies have in common is their massive exposure to emerging markets — in particular Latin America, whose commodity-rich economies are now suffering the fallout from dwindling Chinese demand. In the aftermath of Spain’s real estate collapse, when opportunities at home were almost non-existent, Latin America’s fast-growing economies were a godsend to many of Spain’s biggest companies. But they are fast becoming a curse.

…click on the above link to read the rest of the article…

A Year of Sovereign Defaults?

January 1, 2016

A Year of Sovereign Defaults?

MIAMI – When it comes to sovereign debt, the term “default” is often misunderstood. It almost never entails the complete and permanent repudiation of the entire stock of debt; indeed, even some Czarist-era Russian bonds were eventually (if only partly) repaid after the 1917 revolution. Rather, non-payment – a “default,” according to credit-rating agencies, when it involves private creditors – typically spurs a conversation about debt restructuring, which can involve maturity extensions, coupon-payment cuts, grace periods, or face-value reductions (so-called “haircuts”).

If history is a guide, such conversations may be happening a lot in 2016.

Like so many other features of the global economy, debt accumulation and default tends to occur in cycles. Since 1800, the global economy has endured several such cycles, with the share of independent countries undergoing restructuring during any given year oscillating between zero and 50% (see figure). Whereas one- and two-decade lulls in defaults are not uncommon, each quiet spell has invariably been followed by a new wave of defaults.

The most recent default cycle includes the emerging-market debt crises of the 1980s and 1990s. Most countries resolved their external-debt problems by the mid-1990s, but a substantial share of countries in the lowest-income group remain in chronic arrears with their official creditors.

Like outright default or the restructuring of debts to official creditors, such arrears are often swept under the rug, possibly because they tend to involve low-income debtors and relatively small dollar amounts. But that does not negate their eventual capacity to help spur a new round of crises, when sovereigns who never quite got a handle on their debts are, say, met with unfavorable global conditions.

And, indeed, global economic conditions – such as commodity-price fluctuations and changes in interest rates by major economic powers such as the United States or China – play a major role in precipitating sovereign-debt crises.

…click on the above link to read the rest of the article…

The Fed’s Risk to Emerging Economies

December 21, 2015

The Fed’s Risk to Emerging Economies

MILAN – The US Federal Reserve has finally, after almost a decade of steadfast adherence to very low interest rates, hiked its federal funds rate – the rate from which all other interest rates in the economy take their cue – by 25 basis points. That brings the new rate up to a still-minimal 0.5%, and Fed Chair Janet Yellen has wisely promised that any future increases will be gradual. Given the state of the US economy – real growth of 2%, a tightening labor market, and little evidence of inflation rising toward the Fed’s 2% target – I view the rate rise as a reasonable and cautious first step toward normality (defined as a better balance between borrowers and lenders).

However, other central banks, particularly in economies where the output gap is larger than in the United States, will not be keen to follow the Fed’s lead. That implies a coming period of monetary-policy divergence, with uncertain consequences for the global economy.

On the face of it, a tiny change in the US rate should not trigger dramatic shifts in global capital flows. But, as US monetary policy follows the path of interest-rate normalization, there could well be knock-on effects, both economic and financial, especially in the form of currency volatility and destabilizing outflows from emerging economies.

The reason we should fear this possibility is that the world’s economic equilibrium is both fragile and unstable – and could wobble dangerously without determined and coordinated policy intervention. A Fed rate hike might not tip it over, but some other seemingly innocuous event could.

One doesn’t need a long memory to understand how even relatively modest policy shifts can trigger outsize market reactions. Consider, for example, the “taper tantrum” that roiled financial markets in the spring of 2013, after then-Fed Chair Ben Bernanke said only that policymakers were thinking of gradually ending quantitative easing.

…click on the above link to read the rest of the article…

The Precipice

December 12, 2015

The Precipice

Global markets have found themselves again at the precipice. My sense is that everyone’s numb – literally dazed and confused from prolonged Monetary Disorder and the resulting perverted market backdrop. Repeatedly, “The Precipice” has signaled easy-money buying and trading opportunities. Again and again, selling, shorting and hedging at “The Precipice” guaranteed you were to soon look (and feel) like an absolute moron – for some, progressively poorer dunces the Bubble was pushing yet another step closer to serious dilemmas (financial, professional, personal and otherwise). A focus on risk became irrational. Fixation on seeking potential market rewards turned all-encompassing.

All of this will prove a challenge to explain to future generations. Keynes: “Worldly wisdom teaches that it is better for the reputation to fail conventionally than to succeed unconventionally.” And paraphrasing the great Charles Kindleberger: Nothing causes as much angst as to see your neighbor (associate or competitor) get rich. In short, Bubbles are all powerful.

Going back to those darks days in late-2008, global policymakers have been determined to not let the markets down. Along the way they made things too easy. “Do whatever it takes!” “Shock and Awe!” “Ready to push back against a market tightening of financial conditions.” “Do what we must to raise inflation as quickly as possible.” Historic market excess and distortions were incentivized and, predictably, things ran amuck. “QE infinity.” Seven years of zero rates, massive monetary inflation and incessant market backstopping have desensitized and anesthetized. Rational thought ultimately succumbed to “perpetual money machine” quackery. And now all of this greatly increases vulnerability to destabilizing market dislocations, as senses are restored and nerves awakened.

It was a week of ominous developments among multiple key flashpoints. Let’s start with commodities and EM, where the accelerating downward spiral is now rapidly reaching the status of “unmitigated disaster.”

…click on the above link to read the rest of the article…

What Deflation Quacks Like

December 8, 2015

What Deflation Quacks Like

As yet another day of headlines shows, see the links and details in today’s Debt Rattle at the Automatic Earth, deflation is visible everywhere, from a 98% drop in EM debt issuance to junk bonds reporting the first loss since 2008 to corporate bonds downgrades to plummeting cattle prices in Kansas to China’s falling demand for iron ore and a whole list of other commodities.

The list is endless. It is absolutely everywhere. And it’s there every single day. But how would we know? After all, we’re being told incessantly that deflation equals falling consumer prices. And since these don’t fall -yet-, other than at the pump (something people seem to think is some freak accident), every Tom and Dick and Harry concludes there is no deflation.

But if you wait for consumer prices to fall to recognize deflationary forces, you’ll be way behind the curve. Always. Consumer prices won’t drop until we’re -very- well into deflation, and they will do so only at the moment when nary a soul can afford them anymore even at their new low levels.

The money supply, however it’s measured, may be soaring (Ambrose Evans-Pritchard makes the point every other day), but that makes no difference when spending falls as much as it does. And it does. The whole shebang is maxed out. And the whole caboodle is maxed out too. All of it except for central banks and other money printers.

Everyone has so much debt that spending can only come from borrowing more. Until it can’t. We read comments that tell us the global markets are reaching the end of the ‘credit cycle’, but can the insanity that has ‘saved’ the economy over the past 7 years truly be seen as a ‘cycle’, or is it perhaps instead just pure insanity? There’s never been so much debt on the planet, so unless we’re starting a whole new kind of cycle, not much about it looks cyclical.

…click on the above link to read the rest of the article…

The U.S. Dollar Has Already Caused A Global Recession And Now The Fed Is Going To Make It Worse

November 23, 2015

The U.S. Dollar Has Already Caused A Global Recession And Now The Fed Is Going To Make It Worse

The 7th largest economy on the entire planet, Brazil, has been gripped by a horrifying recession, as has much of the rest of South America. But it isn’t just South America that is experiencing a very serious economic downturn. We have just learned that Japan (the third largest economy in the world) has lapsed into recession. So has Canada. So has Russia. The dominoes are starting to fall, and it looks like the global economic crisis that has already started is going to accelerate as we head into the end of the year. At this point, global trade is already down about 8.4 percent for the year, and last week the Baltic Dry Shipping Index plummeted to a brand new all-time record low. Unfortunately for all of us, the Federal Reserve is about to do something that will make this global economic slowdown even worse.

Throughout 2015, the U.S. dollar has been getting stronger. That sounds like good news, but the truth is that it is not. When the last financial crisis ended, emerging markets went on a debt binge unlike anything we have ever seen before. But much of that debt was denominated in U.S. dollars, and now this is creating a massive problem. As the U.S. dollar has risen, the prices that many of these emerging markets are getting for the commodities that they export have been declining. Meanwhile, it is taking much more of their own local currencies to pay back and service all of the debts that they have accumulated. Similar conditions contributed to the Latin American debt crisis of the 1980s, the Asian currency crisis of the 1990s and the global financial crisis of 2008 and 2009.

…click on the above link to read the rest of the article…

USA Losing Sovereignty to World Fiscal Mismanagement

November 21, 2015

USA Losing Sovereignty to World Fiscal Mismanagement

The IMF and many economists (domestic and foreign) are now warning that a rate hike by the U.S. Federal Reserve, no matter when, will spark a major economic crisis in the emerging markets. They see this crisis being ripe for countries with high budget deficits, such as Turkey, as well as commodity-based economies. This includes the oil exporters such as Russia and even Saudi Arabia who has now begun to issue debt.

This is holding the Federal Reserve’s feet to the fire to the point that they are losing control of their own domestic policy objectives as a consequence of the dollar becoming the WORLD’S ONLY RESERVE CURRENCY no matter what the IMF inserts into the SDR. The emerging economies have issued debt worth nearly half that of the USA without the economic strength to back up that debt. True, there is going to be a debt explosion by 2017 and this is not going to look very nice at the end of the day. Clearly, the Fed is being pressured externally to give up its domestic policy objectives to help the debt burden of everyone else. And people keep saying the dollar will go into hyperinflation? Obviously, they do not understand the world economy or that what is taking place is OUTSIDE of the United States. Sorry, the dollar is not quite ready to burn to ashes.

The Federal Reserve has called a meeting on Monday. This issue of sovereignty will come to a head. The Fed has called this emergency meeting to perhaps change interest rates. The question becomes for who? The lobbying against the Fed to raise rates has been intense. My recommendation is to eliminate the 0.25% paid to banks on excess reserves and raise rates.

…click on the above link to read the rest of the article…

The Last 30 Years of Global Economic History Are About to Go Out the Window

October 18, 2015

The Last 30 Years of Global Economic History Are About to Go Out the Window

Over the last 30 years, a near constant flow of cash has inundated China and other emerging markets. It has lifted those economies, pulled hundreds of millions of people out of poverty, and dictated corporate expansion plans worldwide.

That wave is now ebbing.

Net_capital_flows_to_emerging_market_economies__Annual__Forecast_chartbuilder

This year will see the first net outflow of capital from emerging markets in 27 years, according to the Institute of International Finance, a trade group representing international bankers. The group expects more than $500 billion worth of cash previously invested in things like Chinese factories, Brazilian government bonds, and Nigerian stocks to cascade out of such markets this year.

What’s going on? In a word: China.

In a profound change of narrative for both the global economy and markets that are closely tied to it, the story of fast Chinese growth—a story that has soothed investors and corporate managers around the world since the 1980s—is looking increasingly tough to square with the evidence. And it’s even tougher to imagine anything else like China—a billion new consumers joining the global economy—emerging any time soon.

GDP growth in the People’s Republic fell to 7% per year in the second quarter, according to official numbers—some of the most most sluggish growth since the 2008 global financial crisis.

And most analysts say even those numbers should be taken with a handful of salt. For instance, economic forecasting firm Capital Economics estimates that GDP in the first half of 2015 grew not at 7% year-over-year, but at just above 4%.

Of course, the slowdown in China isn’t confined to China. Over the last 30 years, countries worldwide have built their economies to service the needs of the People’s Republic. Brazil would be a case in point.

Weak Chinese demand hurts China’s suppliers…

…click on the above link to read the rest of the article…

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