International | Oct 27 2015
By Greg Peel
In the mid-1990s, “hot money” flowed abundantly into the “Little Tiger” economies of South East Asia. With Japan in the deflation doldrums and China still then a closed shop, the Little Tigers offered global investors excess returns on the back of rapidly growing economies. However the inflow of capital also affected asset price bubbles, especially in property, which lifted Tiger currencies well above fair value.
The merry-go-round stopped in 1997 when Thailand floated the baht because it no longer had enough reserves to support a US dollar peg. The baht collapsed, the rest of the region quickly followed, and contagion of the Asian Currency Crisis threatened to grip the developed world. Only when the International Monetary Fund stepped in in 1998 was stability restored.
The Global Financial Crisis of 2008 was preceded by developed world property bubbles, most evident in US housing. When it was realised the bubble was being fuelled by unserviceable sub-prime mortgages and related investment instruments, the resultant “credit crunch” resonated around the world and plunged developed economies into recession.
US households immediately responded to the GFC by deleveraging – reducing household debt. Between 2008 and 2013, note Commonwealth Bank’s economists, one trillion dollars was wiped off US household debt. As a result, US consumer spending took a long time to recover despite the Federal Reserve’s attempts to stimulate the US economy through quantitative easing.
As interest rates around the developed world fell to zero, investors went in search of returns elsewhere. They found their opportunity in emerging markets – in the likes of China, Brazil, Russia, Turkey and the aforementioned Little Tigers. The inflow of “hot money” once again spurred on asset bubbles and encouraged the growth of both household and corporate debt in these economies.
Over the multi-year period post-GFC in which US households have deleveraged, ensuring a long, slow US economic recovery, household and corporate debt in emerging markets has expanded from 45% to almost 75% of GDP, CBA notes. Over 2007-14, In Asia ex-Japan, indebtedness in non-financial businesses grew from 10% of GDP in South East Asia to 60%, and to 90% in North Asia. As a consequence, household debt grew by an average 20% in many regional economies over the period.
In late 2013, the Fed announced it was set to start turning off the free money spigot. It was always a risk the Fed’s QE “tapering” program through 2014 would impact on emerging market returns, but the slack was taken up by first the Bank of Japan and the European Central Bank with their own QE programs.
All through 2015, talk has centred around when the Fed might make its first post-GFC rate hike. All through 2015 markets have been worried that such a move would prompt a sharp withdrawal of capital from emerging markets as a tightening of Fed policy allowed for returns to be once again sought domestically. Of course, markets do not wait around to find out. Emerging market currencies have already spent much of 2015 collapsing.
The bearish outlook implied by foreign exchange markets should not be a surprise, suggests CBA, as “the liquidity fuelled leverage binge has reached unsustainable levels at a time when funding cost is likely to rise soon”.
Managing resultant emerging market deleveraging in an orderly fashion represents a key global challenge at this point in time, CBA warns. Even if an actual repeat of the 1997 crisis can be avoided, deleveraging is expected to dampen economic activity for a prolonged period of time. History suggests financial busts associated with a large rise in household debt are followed by an average seven years of household deleveraging.
Last month marked the seventh anniversary of the fall of Lehman. Only this year has US consumer spending begun to show signs of recovery.
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