Blood on the Bourse
By Don Quijones, Spain & Mexico, editor at WOLF STREET
The script of the current dramas besieging the global economy was written seven years ago. It was written when the world’s biggest central banks, with the Federal Reserve leading the way, decided to combat (or at least postpone) an endemic banking crisis by flooding the globe with countless trillions of dirt-cheap dollars, euros, yen, pounds, Swiss francs, and yuan.
With most developed economies stalled and their engines flooded, part of this “hot money” went elsewhere, and much of it poured into the fast-growing developing and emerging markets of Latin America, where it chased high-yield risks that would have been unthinkable, were it not for the newfound abundance of cheap money.
Coinciding with China’s seemingly insatiable thirst for commodities, this sudden glut of global liquidity helped transform Latin America into one of the world’s fastest growing regions. Western corporations, banks and investors also benefited along their way, as their high-yield emerging market investments more than compensated for the lackluster opportunities offered by the stagnating economies of Europe, North America and Japan. For many Spanish multinationals, the region is now the most important source of revenues and profits [read: Downturn in Latin America Mauls Spanish Companies, Threatens Spain’s “Recovery”].
However, seven years after the world’s central banks embarked on the biggest money printing spree in recorded history, the movement of funds has begun reversing — and at a vicious rate!
Blood on the Bourse
With the exception of sub-Saharan Africa – it accounts for half of the 10 worst-performing currencies this year, and its foreign exchange reserves are a 10th or less of the emerging market average – no region is more vulnerable to this reversal than Latin America.
The region’s currencies have just registered their largest cumulative drop in 22 years, as El Financiero reports, a worse performance than during the Financial Crisis or even amidst the region-wide chaos triggered by the collapse of the banking sector of Latin America’s second largest economy, Mexico, during the 1994 Tequila Crisis.
On Monday, Mexico’s currency registered a new historic low as it crashed through the psychological barrier of 17 pesos to the dollar, and today hovers at 17.15. Since August last year the peso has lost nearly one quarter of its value against the dollar.
“It’s a bloodbath, We are seeing panic sales due to global growth fears and the uncertainty around the Fed’s next movement,” said Bernard Berg, a strategist for Societe Generale SA.
As for Latin America’s largest economy, Brazil, which represents 56% of the entire region’s GDP, it is heading towards its longest recession since the 1930s, while its government, like Mexico’s, is mired in a huge, deeply destabilizing corruption scandal.
In the last year alone, the Real has lost a staggering 35% against the dollar, while the Sao Paolo-based Bovespa Index plunged 21% over the same period and is down 15% over the past 30 days alone, despite today’s relief rally! The iShares MSCI Brazil Capped Index Fund sunk to its lowest level of the past decade.
Meanwhile, Latin America’s biggest oil exporter, Venezuela, is home to the highest level of inflation in the world, growing bread lines, empty supermarket shelves, and a collapsing economy. Investors assume with near-certainty that it will default on its dollar-denominated debt.
Even Colombia – supposedly one of the region’s rising stars – is struggling. Its currency, the peso, has suffered the largest drop of the world’s 31 most traded currencies, having lost 36% against the dollar in the last 12 months. The governor of the country’s central bank, José Darío Uribe, said in a recent interview that the country had suffered a serious financial shock from the collapsing price of oil, which represents half of the nation’s exports.
There are many causes of Latin America’s current woes, but the two most important ones – the abrupt end of the commodities super-cycle and the strengthening U.S. dollar – are completely beyond the control of the region’s governments or central banks. Unlike the Fed, the central banks of Latin America can’t print dollars. Instead, they have to dip into their limited foreign exchange reserves.
This is precisely what the Bank of Mexico did on Monday, when it stepped up its market interventions by increasing its daily auctions of US dollars from just over $50 million to $200 million, but to no avail. Given the size of the heavily rigged global foreign exchange markets, on which over $5 trillion worth of currencies are traded each day, a couple of hundred million dollars do not even qualify as a rounding error. It is certainly not enough to stem the tide of global investor sentiment.
As I warned in “Corporate Dollar Debt Explodes in Mexico as Peso Dives,” the current economic troubles in Mexico, as in much of Latin America, in particular Brazil, are not just being fueled by investor sentiment. They are also the direct result of a sharp increase of dollar-denominated corporate debt:
Corporations can borrow more cheaply in dollars. But as the domestic currency falls against the dollar, the dollar-denominated debt held by Mexican corporations with peso-denominated operating income becomes increasingly difficult to service. It’s a recipe for a debt crisis.
Worse still, if the Fed were to do the previously unimaginable and begin raising interest rates this year (a big “IF”), it would drain what little remains of investor appetite for risky emerging market assets. Just as happened in the Tequila Crisis, footloose “hot money” would flee Latin American economies in pursuit of rising U.S interest rates, leaving a trail of devastation in its wake.
And that’s when the real pain will begin. Unlike the rich economies of North America and Europe, Latin American countries have neither the resources nor the social safety net to minimize the economic carnage or mitigate the humanitarian crisis that will inevitably result from the next phase of the Global Financial Crisis. By Don Quijones, Raging Bull-Shit.
So where do we go from here? An Emerging-Market debt crisis, an epic US dollar short squeeze, and many big losers. Read… Fear the Strength of the US Dollar