JOHN MASON: What does the rising US dollar mean for emerging markets?
BY: John Mason
The financial markets of Emerging Market countries are in an out-of-equilibrium situation that won’t regain more stability until the United States central bank, the Federal Reserve System, and the United States financial markets, return to a “more normal” condition.
Right now, Argentina is getting all of the headlines as the rising value of the US dollar threatens the value of the Argentinian peso, the Argentina debt and equity markets, and Argentina's economy.
Sure, the decisions of the Argentina government in the past have helped to create the situation as it exists right now. And, the decisions of the current government of President Mauricio Macri who is trying to reform and stabilize the Argentina economy, will not go without criticism.
Still, one must look back over the last decade to see how the financial markets of the emerging nations fall into such an out-of-equilibrium condition.
Former Federal Reserve Chairman Ben Bernanke explains in his book of reflections on the Great Recession and the following recovery period, The Courage to Act: A Memoir of a Crisis and Its Aftermath, writes about how the Federal Reserve acted to supply sufficient liquidity to financial markets so that other nations around the world, especially Europe, would have the resources to combat the financial meltdowns taking place in their own countries.
In this age of globalization, however, the liquidity spread to other areas in the world. Emerging markets were able to benefit from the flood of dollars spreading throughout the world, take advantage, not only of the availability of US dollars, but also of the very low interest rates that were also permeating the globe.
The cause of the global cascade of US dollars was the three rounds of quantitative easing that the Federal Reserve System pursued to stabilize the US banking system and financial markets in the 2009 through 2014 period. The actions of the Fed were underwritten with the idea that if Fed officials erred in any way during this time, the errors would come on the side of too much monetary ease…and not tool little monetary ease.
As Mr. Bernanke remembered, this monetary ease flowed into Europe to help the eurozone combat the financial difficulties it was facing.
Dollar denominated debt exploded as well as emerging nations took advantage of the situation and drew financial resources into their coffers.
This was the creation of the out-of-equilibrium situation. And, although it has provided these emerging markets with substantial amounts of funds, it has also added to the uncertainty and volatility that these countries face as events in the United States impact the level of interest rates and also the value of the US dollar.
The emerging market nations faced some market volatility before as the Federal Reserve officials moved to end its third round of quantitative easing.
Concern arose that liquidity would be drawn out of world markets as well as out of United States markets and that United States interest rates would rise threatening the ability of nations in the emerging markets areas of the world to repay or to refinance their debt.
For a short time, these nations faced some real uncertainty about the outflow of money from their countries as the value of the US dollar strengthened and United States interest rates rose.
We had a “taper tantrum,” as it was called, a market disruption as the Federal Reserve began to “taper” its purchases of securities so as to end the era of quantitative easing.
As noted by many economists at the time, the disruptions coming to the emerging markets were caused by a “trigger” from the developed world that set off the crisis.
And, so, analysts are concerned that the developed world might be setting off another “trigger” in the current situation.
In recent years, in the developing world, there has been a rapid rise in debt, with a large amount of the debt being dollar-backed debt. There have been high current account deficits. And there has been runaway inflation in many countries. Argentina this past year faced an inflation rate of 25 percent, and although the government has a target of 15 percent for this year, many believe that this rate of inflation in unachievable.
The value of the US dollar began to rise in February, after falling for more than 14 months. By April, Argentina was beginning to feel some pain. Both the stock market and the bond market in Argentina were hit, with the debt markets suffering most.
And, the strength of the US dollar continued to grow, the Federal Reserve raised its policy rate of interest again in March, and longer-term interest rates in the US rose with the yield on the 10-year US Treasury note hitting 3.00 percent a week ago.
Although the economic growth in emerging market countries continued to remain relatively strong, evidence grew of a slowdown in international growth, and the price of oil began to climb.
Now, concern was raised not only about Argentina, but other countries like Turkey, who also had a big current account deficit and other country imbalances. South Africa, Ukraine and India who have high financing needs drew the attention of analysts. And then there were others, like Hungary, Korea, Thailand, Poland, and Mexico, all of whom seemed to have stretched asset values.
Right now, the situation has only just presented itself. But, there are evolving factors that may impact these countries that cannot be ignored.
The big concern is just how much longer will the value of the US dollar continue to rise?
The major factors here seem to be, one, that the Federal Reserve is moving with great resolve to return interest rates and its balance sheet back to “more normal” levels. This effort seems to be having a major impact on the value of the dollar and, as long as the Fed moves in this direction, it will continue to have a major impact on the value of the dollar.
Second, the price of oil has been moving up. And, with the situations in Iran and Venezuela being so unsettled, many believe that oil prices will go even higher than $70. This will be quite unsettling if this takes place.
Third, the world economic scene seems to be a bit “chancy” right now. Economists seem to be lowering growth rates while policy makers, especially in Europe, seem to be afraid to begin raising interest rates, thus falling further and further behind the US move to “more normal.”
Thus, things really appear to be out-of-equilibrium, and so we can expect more instability and volatility. In fact, right now, one cannot see this world condition ending soon.