Tuesday , 23 April 2024

Emerging Markets Will Initiate Next Financial Crisis – Here’s Why

Global financial crises tend to happen in seven-year periods, and there is mounting evidence that the market is approaching another lead by the emerging markets.

The above comments, and those below, have been edited by Lorimer Wilson, editor of munKNEE.com (Your Key to Making Money!) and the FREE Market Intelligence Report newsletter (see sample here – register here) for the sake of clarity ([ ]) and brevity (…) to provide a fast and easy read. The contents of this post have been excerpted from an article* by Mercenary Trader (mercenarytrader.com) originally posted on SeekingAlpha.com under the title The Next Global Financial Crisis: Chinese Meltdown, U.S. Dollar Strength And The ‘Original Sin’ Pose Significant Risks To Emerging Markets ‏ and which can be read in its unabridged format HERE. (This paragraph must be included in any article re-posting to avoid copyright infringement.)

Looking back in history, major financial events happen every five to seven years or so, as the below image via State Street makes clear:

As to why this is the case, we see a logical middle ground between:

  • a belief in mysterious forces (e.g. “waves” of unknown nature),
  • an understanding of human cyclical patterns that repeat for logical reasons, like the 17-year Cicada cycle or the standard stages of madness in crowds and the time it takes for emotional cycles to play out (apathy, skepticism, optimism, euphoria, delusion, anger, denial, despair – at which point the loop then repeats) and
  • hard “machine” style factors of the type Ray Dalio describes, via Bridgewater, with the entire world as the machine: Build-ups of credit and leverage, historical behavioral patterns in light of rational hidden drivers behind economic cycles, and so on.

As of now, we see Austrian cycles of capital misallocation coming to bear in China, with painful implications for emerging markets.

Why EM?

What are the causes for thinking that, yes Virginia, EM is where this crisis is likely to kick off?…[we;;,] it’s all about exposure levels, debt build-up, and hostile monetary policy. To wit:

  1. EM is most exposed to China-driven commodity collapse.
  2. EM has elevated levels of dollar-denominated debt.
  3. EM is most exposed to currency and trade war fallout.
  4. EM is most exposed to Federal Reserve tightening.

(click to enlarge)

1. EM is most exposed to China-driven commodity collapse

First look to commodity prices…and consider that 1) global commodity consumption is driven by China, and 2) global commodities are largely supplied by emerging markets. The world is now adjusting to the reality that China’s endless growth may well and truly be ending. The Ponzi capex boom had to cease and desist at some point, and even China’s broad demographics are turning south.

2. EM has elevated levels of dollar-denominated debt

Consider the fact that EM countries spent the past six years doing something ill-advised: racking up ever higher levels of debt (even as developed world countries cut back on debt).

3. EM is most exposed to currency and trade war fallout

When China announced a surprise devaluation of the yuan last week (the largest in decades), the decline among various EM currencies was like a who’s who of pain.

(click to enlarge)

The size of the devaluation, a mere blip in the big scheme of things, was the smallish appetizer at the beginning of a large meal: an expectation that more, perhaps much more, devaluation will be coming. In fact, China may have quite, by bumbling accident, guaranteed the need to devalue further:

  • Fears of a further weakening currency could now accelerate capital flight via investors and mainland Chinese, making an existing problem an even more serious one…
  • Another large devaluation would both help exports further and “rip off the band-aid” (thus causing capital flight to stop) but such an act – not to mention China’s willingness in general to “export deflation” by cutting prices – is extremely harmful to EM nations (which have racked up large debt levels). This in turn means more currency war on deck, with emerging markets being the players least suited to handle it.

4. EM is most exposed to Federal Reserve tightening

…Given America’s status as the world’s largest economy, with 20-25% of global GDP or thereabouts, the monetary policy for Uncle Sam is by and large the policy for everyone. This means the beginning of a hiking cycle serves as fiscal tightening for debt-leveraged EM countries who further complicate the situation having racked up trillions in non-local, dollar-denominated debts.

5. Crashing price of oil makes EM one of the most vulnerable areas of the global economy

Last but not least, one should consider that the price of oil is crashing and could be headed for $30 a barrel, and that any “risk off” trigger elsewhere in the global asset complex – as with an abandonment of energy debt for example – could lead to follow-on rampant selling in EM as one of the most vulnerable areas of the global economy.


Putting it all together, with price, data and events all confirming the gloom (Brazil debt was just downgraded to junk as China slows day by day), and it is not hard to see just how the tightly coupled complex system that is the global market faces blowup risk via EM.


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