Oh, Great: A Second Epicenter

Paul Krugman:

“The really shocking thing, however, is the way the crisis is spreading to emerging markets — countries like Russia, Korea and Brazil.

These countries were at the core of the last global financial crisis, in the late 1990s (which seemed like a big deal at the time, but was a day at the beach compared with what we’re going through now). They responded to that experience by building up huge war chests of dollars and euros, which were supposed to protect them in the event of any future emergency. And not long ago everyone was talking about “decoupling,” the supposed ability of emerging market economies to keep growing even if the United States fell into recession. “Decoupling is no myth,” The Economist assured its readers back in March. “Indeed, it may yet save the world economy.”

That was then. Now the emerging markets are in big trouble. In fact, says Stephen Jen, the chief currency economist at Morgan Stanley, the “hard landing” in emerging markets may become the “second epicenter” of the global crisis. (U.S. financial markets were the first.)

What happened? In the 1990s, emerging market governments were vulnerable because they had made a habit of borrowing abroad; when the inflow of dollars dried up, they were pushed to the brink. Since then they have been careful to borrow mainly in domestic markets, while building up lots of dollar reserves. But all their caution was undone by the private sector’s obliviousness to risk.

In Russia, for example, banks and corporations rushed to borrow abroad, because dollar interest rates were lower than ruble rates. So while the Russian government was accumulating an impressive hoard of foreign exchange, Russian corporations and banks were running up equally impressive foreign debts. Now their credit lines have been cut off, and they’re in desperate straits.

Needless to say, the existing troubles in the banking system, plus the new troubles at hedge funds and in emerging markets, are all mutually reinforcing. Bad news begets bad news, and the circle of pain just keeps getting wider.”

Krugman is not alone: stories about currency crises and emerging markets are popping up all over. The WSJ:

“Sharp moves in global currency markets are being driven by short-term factors such as the fear of economic distress and the unwinding of trades that depended on borrowed money. But the currency swings are likely to have long-term economic implications for developed and emerging economies.

The dollar and the yen have both soared against nearly every other global currency over the past month as investors became convinced that a world-wide recession was looming.

The dollar has strengthened 16% against the euro, 24% against the Mexican peso, and 9% against the Russian ruble and on Friday it hit a high against the Indian rupee. The surge has brought to an end 2 1/2 years of dollar weakness, according to a Federal Reserve index that measures the buck against 26 currencies. (…)

For emerging markets, rapid currency declines have been “very disruptive,” says Richard Clarida, global economic adviser at Pacific Investment Management Co. and a professor at Columbia University. “It ends up impairing confidence in markets and generating an inflation problem.”

To combat these sharp moves, Brazil, Mexico, Russia, and India collectively have drawn down their reserves by more than $75 billion since the end of September, selling dollars to protect their currencies, according to Win Thin of Brown Brothers Harriman.”

Check out what’s happening to some stock markets overseas:

“Markets down more than 70%: Vietnam (-70.5%), Peru (-73.2%), Ireland (-73.4%), Russia (-73.9%), Iceland (-88.7%).

Markets down between 60% and 70%: Hong Kong (-60.1%), Poland (-62.6%), China (-69.8%).

Markets down between 50% and 60%: South Korea (-54.5%), Italy (-55.2%), Egypt (-56.9%), Brazil (-57.2%), Japan (-58.1%), Singapore (-58.2%), Turkey (-58.5%), India (-58.3%).”

(You might ask: isn’t Pakistan supposed to be having trouble? Yes, but they’ve put an artificial floor on their stock market, so it can’t go down.)

When a country’s currency tanks, imports become more expensive, and any debt it has that’s denominated in a foreign currency suddenly becomes a lot more expensive. For countries that depend on imports and foreign capital, or that have substantial debts that are not in their own currency, it can be ruinous. A lot of developing countries really don’t have piles of spare money just lying around, waiting to be used for the defense of their currencies. Nor can their economies absorb serious capital flight.

Cleveland has it bad. But developing countries have it much, much worse. And something tells me that neither foreign aid nor charitable giving are going to be very strong for the foreseeable future.

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