“Hot Money” gets cold feet: the 3 Steps to a Panic
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
Two of the most important guardians of global finance, the IMF (International Monetary Fund) and the IIF (Institute of International Finance), gave their verdict on the current state of the global economy this week. And their message could not be clearer: beware the dreaded fate of emerging markets.
The World According to A Prestigious Club of Global Banks
The IIF warned this week that hot money is pouring out of emerging markets at a startling rate, primarily on the back of China’s crunching slowdown and rising fears of a looming US rate hike.
Before we go any further, here’s a caveat: The IIF is a prestigious “club of global banks.” After the Club of 30, it is arguably the most powerful financial lobby association on the planet. It is also one of the strongest proponents of self-regulation in banking, a major cause of the Global Financial Crisis. Could an organization like the IIF have ulterior motives?
This year capital outflows from emerging economies will surpass inflows for the first time since 1988. Residents sending cash out of the emerging markets has accelerated amid recent financial market volatility while at the same time foreign investment is set to nearly halve from $1,074 billion in 2014 to just $548 billion this year.
The countries most at risk are those with high current account deficits, pronounced levels of corporate debt denominated in foreign currencies, and extreme political uncertainty. Brazil, whose currency has suffered a 30% currency depreciation this year, and Turkey (15%) are among the nations “in this situation,” the report warns. The nation most at risk is Venezuela, which (according to estimates by US financial firms) is currently suffering annual inflation of 120%. The country’s risk of default is “extremely high” and could even happen as early as 2016, warns the IIF.
The last time such a large amount of hot money spewed out of emerging market economies was at the height of the 2008/09 global financial crisis. This time around, the capital exodus is being driven by internal, rather than external factors, claims the IIF — a rather bizarre claim given that the three most important causes of emerging market woes (China’s rapid slowdown, the abrupt end of the commodities super-cycle, and the strengthening U.S. dollar) are: a) international in scope; and b) beyond the control of emerging market governments or central banks.
Emerging markets’ current predicament would have been unimaginable without the groundwork laid by Western central banks. In a desperate bid to contain (or at least postpone) an endemic banking crisis that they themselves were complicit in fueling, the world’s largest central banks flooded 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, most of this “hot money” went headfirst into fast-growing developing and emerging markets to chase high-yield risks that would have been unthinkable, were it not for the newfound abundance of cheap money.
Hot Money Gets Cold Feet
Now, after years of ZIRP, the mere thought of the Fed raising rates by a paltry quarter-point or two is enough to send already jittery investors into a stampede of terror. As a result, trillions of dollars of hot money are suddenly getting very cold feet, especially amidst rising fears over the prospect of emerging-market governments imposing capital controls.
As Reuters reports, many of the countries involved have past form:
Some governments are already restricting citizens’ ability to move cash freely or tightening existing measures and some foreign investors worry they may be next in line.
As 2015 outflows from emerging stock and bond funds near $100 billion and currencies from Malaysia to Brazil plumb multi-year lows, memories are stirring of past controls that block unlucky investors’ exits.
At stake is the $7 trillion that the Institute of International Finance reckons has flowed into emerging markets since 2005, via direct investments, mergers and acquisitions, and stock and bond purchases. Some of those with EM exposure may be considering moving before regulators do.
A statement this week by IMF President Christine Lagarde that emerging markets will probably see even more volatility ahead is unlikely to help matters. This volatility is not just being fueled by investor sentiment and fears over capital controls. They are also the result of a sharp increase of dollar-denominated corporate debt.
In its latest Global Financial Stability Report, the IMF estimates that between 2004 and 2014 the emerging markets’ total corporate debt load grew from $4 trillion to $18 trillion:
Debt held by firms in emerging market economies in a currency other than their own poses extra complications these days. When the U.S. Fed does eventually raise interest rates, the accompanying further strengthening of the U.S. dollar will mean an emerging market’s own currency will depreciate against the higher value of the U.S. dollar, and would make it increasingly difficult for firms to service their foreign currency-denominated debts if they have not been properly hedged.
If the initial phase of this interminable Global Financial Crisis taught us anything, it is that very few players are “properly hedged”.
A Three-Step Process
Right now the biggest problem for emerging markets is confidence. Fear, like greed, is highly contagious and fearful funds can move at lightning pace in today’s highly globalized, financially liberalized world.
Financial crises are becoming increasingly common as the global economy becomes increasingly interlinked, Paul Krugman warned back in the year 2000. Most emerging market crises tend to be generated by a self-fulfilling process of capital flight (due to a large pool of extremely mobile funds, the “hot money”), balance sheet calamities (because local firms hold large debts in foreign currency), and panic (as investors succumb to individually rational but collectively disastrous fears).
The fears are being stoked, whether intentionally or not, by the high priests and priestesses of global finance. Sound familiar? It’s playing out right now across numerous national economies. And once the process begins, it’s very difficult to stop. By Don Quijones, Raging Bull-Shit.
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