One reason why the financial crisis that came to a head a decade ago, with the collapse of Lehman Brothers, blindsided Wall Street and the City was that crises were not supposed to happen in advanced economies with sophisticated financial systems. Instead their preferred habitat was emerging markets, notably in Latin America in the early 1980s and Asia in the late 1990s. Now another crisis is taking hold in that more familiar domain. The emerging markets most afflicted up to now—Argentina and Turkey—are particularly vulnerable because of deep flaws, past and present, in their economies and politics. But the main cause of the distress lies elsewhere, in the United States, as the Fed tightens monetary policy, sucking in funds from around the world and strengthening the dollar. That is why countries as diverse as Indonesia and South Africa are also under pressure as their currencies lurch down in value. The Indonesian rupiah is trading at its lowest against the dollar since the Asian crisis two decades ago. The South African rand has fallen by a fifth against the dollar this year, a further headache as the economy slides into its first recession for almost a decade. For much of August Turkey was in the firing line as the lira tumbled, falling one day by 14 per cent against the dollar and now over 40 per cent down from the start of the year. In common with all currency crises, there were domestic as well as wider international reasons. As President Recep Tayyip Erdogan has steadily strengthened his political grip on the country, he has forfeited the confidence of international investors anxious about Turkey’s ability to finance its big current-account deficit, which was 5.5 per cent of GDP last year. That left Turkey vulnerable to an escalating dispute with America over its detention of Andrew Brunson, an American evangelical preacher, which prompted President Trump to double tariffs on Turkish steel and aluminium last month.
“As the Fed tightens monetary policy, it is sucking in funds from around the world”
Erdogan’s bizarre characterisation of interest rates as the “mother and father of all evil” is a black mark for a country that urgently needs to raise them. Another worrying sign is the appointment of his son-in-law, Berat Albayrak, as finance minister in July. All that follows an increasingly wayward growth-at-all-costs policy that has lost Turkey the reputation it won more than a decade ago for prudent economic management. That has taken its toll: consumer-price inflation surged to almost 18 per cent in August, the highest for nearly 15 years and far above the official 5 per cent target. Yet more recently Argentina has also been punished, even though the reforming President Mauricio Macri has been striving to do the right thing. The central bank did not flinch from pushing interest rates up by an extraordinary 15 percentage points at the end of August (to 60 per cent) in an attempt to stabilise the sliding peso, which has fallen around 50 per cent this year. Moreover, the government secured in June a big line of credit from the International Monetary Fund. The good works have been in vain. Argentina is once again under extreme pressure, in part because it is haunted by the debt default of 2001 and the subsequent tussle with “holdout” creditors (who had not settled with the government as most bondholders had done), which caused a further default in 2014. Despite their differences, both Turkey and Argentina have been hit by a common shock as they toss and turn in the turbulent backflow of the shift in American monetary policy. A foretaste of what is now happening was the “taper tantrum” of 2013 when emerging markets were battered after Ben Bernanke, the-then Fed chairman, aired in May the possibility of phasing out its monthly asset purchases. Investors took flight and emerging market currencies suffered though the pain was contained when the Fed postponed the decision until the end of the year.
“Debt in emerging markets excluding China rose from $15 trillion in 2007 to $27 trillion last year”
Now the Fed has gone a step beyond heralding the end of quantitative easing by starting to run down the stock of assets it has bought. Combined with that, the American central bank has also been raising interest rates with increasing urgency since the end of 2015 when it first edged them up. At first the increases were tortoise-like (there was just one quarter-point rise the following year) but of late they have become more hare-like, with two quarter-point rises already so far this year. The Fed’s main policy rate now stands at between 1.75 and 2 per cent—1.75 percentage points higher than at its nadir for seven years after the crisis of 2008. Another quarter-point increase is expected when the Fed meets towards the end of September. The tightening in American monetary policy hurts emerging markets—and hurts the most vulnerable of them the most. Although developing economies become more competitive as their currencies weaken—tourists have been flocking this year to Turkey—this economic boost is outweighed by the financial effects of depreciating exchange rates. This injures in particular domestic firms that have borrowed in dollars but whose revenue streams are in local currency. Turkey’s non-financial firms had foreign currency debt worth around $300bn at the end of last year, equivalent to a third of GDP. Turkish banks are also vulnerable because of their foreign currency borrowing. As with all crises, the seeds of this latest one were sown in the good times. During the unprecedented period of ultra-loose monetary policy following the financial crisis of 2008, debt surged in the developing world. According to the Institute of International Finance, debt in emerging markets excluding China has risen from $15 trillion at the end of 2007 to $27 trillion at the end of last year. An even bigger borrowing surge occurred in China, which is now trying to contain credit to ensure it does not undergo a crisis itself. The resulting Chinese slowdown has curbed its gargantuan demand for raw materials, causing prices such as that for copper to swoon. That is a heavy blow for resource-rich emerging economies. Ten years after the global financial crisis, this emerging crisis may appear to be an unrelated twist. It is not. The troubles mark a further stage in a global cycle, in which the stimulus in advanced countries and China in response to the 2008 crisis spilled over into a further build-up in debt, this time in emerging markets. Now the bill is being presented.
