Emerging markets crisis

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Emerging markets are defined as economies which are making the transition from a low income / developing economy to a high income ‘developed’ economy. Key emerging markets include: China, India, Brazil, Mexico. Emerging markets are mostly based in South East Asia (excluding Japan) and Latin America. Emerging markets often have a high rate of economic growth, but can be more vulnerable to crisis of confidence due to misaligned exchanged rates and/or bad debts.

In recent months, several emerging markets have seen a fall in the value of their currency due to concerns over aspects of their economy. This has led to a wider contagion (spreading of fear and concerns) to other emerging markets.

bank-Argentina
National bank of Argentina

Causes of the Emerging Market crisis

1. Individual country specifics. The crisis is partly caused by specific problems in individual countries  (e.g. Argentina, Turkey, India)

  • The worst affected economy is probably Argentina. Argentina suffered a severe economic crisis in 1998-2002 where Argentina defaulted on government (sovereign debt) and was frozen out of international bond markets. The Argentina economy did recover, but similar problems are now returning. The problem is that memories of the last crisis are fresh in people’s mind, undermining confidence in the Peso. Also, Argentina is struggling to finance its government debt.
  • Argentina is facing inflation of up to 30%. This is causing people to lose confidence in the currency (Peso). Despite restrictions on exchanging currency, many Argentinians are buying dollars on the black market (at 12 Pesos to 1 Dollar) This is a worse exchange rate than the official exchange rate of (8 to 1), but Argentinians worry the devaluation in the Peso will continue making their currency weak.
  • Foreign exchange reserves in Argentina are falling as the government unsuccessfully tries to prevent the fall of the Peso. To stem the flow of foreign exchange reserves, the government have implemented controls on buying foreign goods online, but this has also decreased confidence.
  • Rapid devaluation. Because of fears over inflation, government debt and lack of foreign reserves, the Peso has fallen at a faster rate than in 2002. This will aggravate Argentina’s inflation, (because imported raw materials will become more expensive after devaluation). However, devaluation will help Argentinian exports become more competitive.

2. Fed Tapering

The realisation the US Fed Reserve will soon begin tapering its bond purchases was a factor in precipitating some of the currency falls and concerns over emerging markets. A Fed tapering raises prospects of higher US interest rates making the US more attractive to foreign investment. Emerging markets have benefited from an inflow of capital during the US / global financial crisis, causing an appreciation in Emerging market currencies. But, this factor is now liable to be reversed.

Brazil’s President Dilma Rousseff complained recently that “the withdrawal of the monetary stimulus in developed countries” was fuelling “market volatility.”  Some have even suggested unfair currency wars.

An end to ultra low-interest rates in the US, will see capital flows return to the US. Also, in a few years, the EU could become more attractive for capital flows.

3. Fears of slower growth in China

Despite economic growth of 7 – 7.5%, some fear that the Chinese economy is hiding underlying weaknesses. Analysts jumped on a survey which suggested manufacturing output was falling in China. There are also concerns about the level of bad debts in the Chinese banking system. To some analysts, China has worrying signs of a property and investment bubble, which could burst with devastating consequences. China is important for emerging markets because it is a big purchaser of raw materials and commodities, which are a source of growth for other emerging markets. Lower demand for commodities leads to lower prices and lower incomes. China is also a big investor in emerging markets. A real slow down in China would have a big adverse effect on other emerging market economies.

However, fears of a Chinese economic slowdown may be exaggerated. A one-off survey on manufacturing output is not necessarily a reliable guide to the economy. There are hopes that the Chinese economy will become increasingly diversified and a growing Chinese middle class could become a new source of import buying, which will benefit the world economy.

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Factors affecting US Bond market

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Readers Question. The fear of rising interest rate is spooking markets in USA.  So is it because of tapering? – Less and less buying of securities. Or the rise of inflation is expected. Or is it the economy picking up? Firstly, it is important to keep markets in perspective. On Jan 24, the U.S. 10-year …

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Favourite economist and book

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Who is your ‘favourite’ economist, why? It may not be very original, but I would choose the man himself. John M. Keynes. Why? This is more interesting. Keynes was very practical. He saw a real crisis – the great depression, and he sought an effective solution. In looking for solutions he was willing to think …

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Which will be best currency for an independent Scotland?

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Readers question: Would Independent Scotland be better with the Pound, Euro or an independent currency? What are the risks for each scenario?

Scotland using the Euro

If Scotland use the Euro there will be some benefits from having a shared currency with the rest of the Eurozone.

  1. Scottish business and personal users will have lower transaction costs when travelling to Europe.
  2. Having the Euro could possibly encouraged foreign investment from European firms wishing to invest in a part of the British Isles now using the Euro.

However, these benefits of the Euro are significantly diminished by the new additional transaction costs of exchanging currency with the rest of the UK. Cross border trade with England is likely to dwarf the number of Scottish people travelling to the continent.

Also, given the ease with which business can convert currency and hedge against currency movements, I don’t feel that the UK has been at a significant disadvantage to retaining the Pound.

A much bigger issue for Scotland using the Euro is the very real concern that Scotland could face similar problems to other peripheral countries. What are the risks of Scotland using the Euro?

  • Scotland will have monetary policy set by the European Central Bank. You could argue the Bank of England don’t always set interest rates according to the interests of the Scottish economy. But, there is likely to be a greater divergence between Scotland and the rest of the Eurozone. If Scotland join the Euro and experience ECB interest rates (set for 16 countries), Scotland could face high interest rates when in recession or low interest rates when the economy is picking up with inflationary pressure.
  • Bond market. In the recent recession, the Bank of England has been active in buying government bonds. This has provided sufficient liquidity in the bond market. The consequence is that bond yields on UK debt have fallen to near record lows. By contrast, countries in the Eurozone have suffered from periods of very high interest rates. Markets fear the liquidity of Eurozone countries because the ECB has not always been willing to act as lender of last resort.
  • Note: Some countries have seen rapidly rising interest rates with reasonably low levels of government debt. Bonds spiked in Spain and Portugal, despite government debt as a % of GDP being relatively low at the time.
  • To some extent the ECB has overcome this issue by its greater willingness to intervene in the bond market. But, there is no guarantee the ECB will always have the willingness and ability to decisively intervene in the bond market.

There is a real concern that if Scotland adopts the Euro it will face two potentially very damaging problems

  1. Higher bond yields, increasing cost of debt payments.
  2. Greater pressure for austerity. Euro members have faced much greater pressure to cut government spending and balance the budget. The problem is that this pressure to pursue austerity in a recession has been economically very damaging. It has cause much higher rates of unemployment across Europe than compared to the UK.
  • Trade imbalances. Another feature of the Euro is that peripheral countries have often found themselves becoming uncompetitive within the Eurozone. For example, Spain and Greece saw rising wage rates and higher costs push inflation. But, because they cannot devalue in the Euro, they just became uncompetitive. This led to record current account deficits and lower economic growth. The process of internal devaluation to restore competitiveness has led to many years of low growth and high unemployment.

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France vs UK recovery

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Useful post from Paul Krugman about a comparison between the French and UK recoveries. It stems from comments by a Conservative cabinet minister that ‘the French economy is being run into the sand.’ For those who can’t get past the NY Times paywall, I’ll post the two graphs here. UK and France since 2010 The …

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Ask an Economic Question 2014

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You are welcome to ask any questions on Economics. Though you might also like to try google custom search (top right) to see if the topic has been covered before. I am looking to explain economic principles / ideas/ recent developments in economics. I can’t promise to answer, but will try if it meets the …

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Labour plans for bank reforms – UK Bank market share

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Readers Question: would you be able to comment on what the Labour party’s latest proposal to break up the banks to create competition? I can see some reasons that relate to safe guarding possible failures of large banks which can prove costly if the government are needed to bail them out. However, in terms of helping to stimulate economic growth, would it help or is it like shuffling a deck of cards? I would greatly appreciate hearing your opinion on this.

Labour bank reforms include:

  1. A cap on the size of banks’ market share; this will involves splitting up large banks, such as Lloyds and RBS
  2. The introduction of two new challenger banks with an 8% market share.
  3. Refer the issue of banking competition to the Competition and Markets Authority (CMA), within one year of being elected.

Motive for bank reforms

  • The UK banking sector has become more concentrated in recent years. This has created less competition and more market power. If the government is able to reduce market concentration and increase competition, then they hope that consumers will benefit from more choice and greater price competition. If the banking sector becomes more competitive, the theory is that it will put downward pressure on the cost of borrowing, and upward pressure on saving rates.
  • The OFT found in a review of the current account market that, while the share of the four largest providers fell from 74 per cent in 2000 to 64 per cent in 2008, it then rose to 77 per cent in 2010.

bank-marketshare

  • A report by Bain & Company,  showed that the market share of the top six banks together account for 91% of retail deposits. The problem of high market concentration of retail banks is that market power leads to dominance in related financial products, such as mortgages, loans and overdrafts.
  • Reducing the size of banks helps to deal with the issue of banks which are too big to fail. After the credit crisis, the government had to bail out large banks, at a cost to the taxpayer. Reducing the size of banks means that any bailout will be less costly.

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