Announcing this year’s traditional autumn crisis

September 6, 2013 8:32 pm

Announcing this year’s traditional autumn crisis

By John Dizard

Emerging market worries replace the time-honoured eurozone crackup farce, finds John Dizard

So, summer is over and everyone in the money world is getting ready for the traditional autumn crisis. Of course we will have the, now time-honoured, eurozone crackup farce. Show times will be set and the cast members announced after the German election in two weeks, ready for the IMF-World Bank meetings in mid-October. There may, though, be something Different This Time. You will notice that after the spring and summer market hiccups and corrections, a couple of asset classes are not only coughing, but coughing up some blood. Emerging market-traded debt and equities, even after last week’s little rally, have continued to lose international investors’ cash and confidence.Multilateral Man, from the IMF staff to the courtiers whispering to rich countries’ heads of government, is wondering if “EM” is turning into a “systemic risk”. You know, like “Lehman”. Do rich-world investors or taxpayers have to pay for the losses?

The answer, I believe, is that there is a systemic risk developing from the drain of investor money out of emerging market debt and equity funds, but that risk is not an immediate threat to the rich world’s central banks, commercial banks, investment dealers or taxpayers. This time, the systemic crisis will swirl around EM central banks and those dependent on their ability to maintain independent convertible currencies. When you sell EM shares or bonds in the years to come, you may not get dollars or euros in return for rupees or reals with quite the same ease you have come to expect. The losses, though, will be spread out among the broadly defined investor class, rather than concentrated on the balance sheets of large banks and dealers that would have to be recapitalised by rich-world taxpayers.

The threat of financial crises in the developing world spreading to the rest of the globe was supposed to have been seen off after the Latin American banking crisis of the late 1980s and early 1990s, and the Asian crisis of 1997, which followed a collapse of fixed exchange rates for overpriced and over-borrowed local currencies. Huge foreign exchange reserves were piled up by EM central banks, who also arranged bilateral currency swap lines to prevent recurrences of such shocks.

Those resources of ready cash provided comforting bullet points for the world’s securities sales forces, who told rich-world investors “never again” with conviction.

And yet . . . trees don’t grow to the sky, not even in Brazil or India. Yes, the working-age populations have been growing faster than in Europe, Japan or the US, but the highly skilled part of the workforce in much of the developing world is smaller, and harder to increase quickly, than you would conclude from the advertising inserts and dealers’ PowerPoint presentations. According to a recent report from Citi Research discouragingly titled “Tourist Traps”, real annual credit growth in emerging markets between 2004 and 2011 was, at 13.9 per cent, running at about twice the rate of real growth in gross domestic product.

Let us go back to the most interesting example of right-questions-asking to come out of the Federal Reserve in recent years: Governor Jeremy Stein’s “Remarks” on February 7 of this year. He wrote: “In principle, what we’d really like to know, for any given asset class – be it subprime mortgages, junk bonds or leveraged loans – is this: what fraction of it is ultimately financed by short-term demandable claims who are likely to pull back quickly when things start to go bad?”

Now, does not the idea of being able to “pull back quickly when things start to go bad” sound like a good idea? If you had the bad luck to be a US money-centre bank lending to Mexico in 1982, though, you could not pull back quickly. If, however, today you are an EM debt mutual fund owner, or EM equity exchange traded fund holder, you can sell at a low transaction cost with a double click on your laptop screen.

Back in the 1980s and 1990s, when sovereigns short of foreign exchange restructured their debt, bondholders tended to get preferred treatment, since their proportion of total obligations was small, and litigating with them was too much trouble. Not so now. Since the 2008 financial crisis, cumulative bank lending to emerging markets has been around $100bn. In contrast, EM debt and equity portfolio investment rose by more than $700bn.

That is probably a bit more than the global dealers’ market-making desks will be willing to put on their balance sheets if the holders were to try and cut their positions in a month or two. That leaves two ways out for EM central banks: pay the foreign exchange to cover portfolio investor sales out of their reserves, or devalue to the point where the would-be sellers give up and hold on to the paper.

Oh, there is a third way. The EM central banks can impose capital controls.

Welcome to 1932.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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