"Mother of all currency crises" to hit emerging market economies?
By Jon Fernquest |
How vulnerable is Thailand to the ongoing global financial crisis?
This has to be the question on everyone's mind.
Unlike the 1997 Asian Crisis, financial contagion has already spread from the US, to Europe, and finally to emerging market economies, the most vulnerable of all (Russia, Korea, Brazil, Hungary, Iceland,Belarus, Ukraine, Serbia, Pakistan, Mexico...).
There are three ways in which emerging market economies are vulnerable:
1. Declining exports during global recession.
2. Declining capital inflows reducing investment funds available for business.
3. Declining credit availability due to difficulty rolling over short-term debt by banks.
(Source: The Economist, 23-10-08, link)
Currency crisis warning from economists
Led by this year's Nobel laureate Paul Krugman, economists are predicting a "mother of all currency crises" in emerging market economies (See Krugman and Dani Rodrick, and Mark Thoma). As Harvard economist Dani Rodrick describes it:
Combine a deep recession in the advanced countries with an uncontrolled depreciation of emerging-market currencies, and the pressure to erect trade barriers in the U.S. and Europe will be impossible to withstand. A vicious cycle of unemployment and protectionism feeding on each other a la 1930s could transform the deep recession everyone is already expecting into a second great depression. It can get worse...(Source: Dani Rodrick)
(Update: Krugman has devoted his weekly commentary at the NY Times on this problem: link)
IMF should move with currency swap arrangements
In the Financial Times William Rhodes, president and CEO of Citibank, today urges:
First, the IMF should facilitate the expansion of currency swap arrangements, working with the central banks of the developed world, to allow emerging markets to have the same funding access to currency swaps that have been made available to developed economies. This will ensure a smooth functioning of the foreign exchange and interbank markets and will be of global benefit as non-US central banks will be able to provide dollars to financial institutions in their jurisdictions; at the same time, pressure will be relieved on US funding markets.Second, contingency funding facilities should be established. As part of the response to the Asian crisis of 1997-98, the IMF introduced Contingent Credit Lines, to provide a precautionary line of defence for those members with sound policies, that were not at risk of an external payments crisis of their own making, but were vulnerable to the contagion effects of capital account crises in other countries. Under the facility, an IMF member that met certain criteria could draw on a large pre-specified amount of resources if it was hit by a financial crisis because of factors outside its control. Such mechanisms have failed in the past because of excessive IMF conditions and the perception that there was a stigma attached to countries that drew on such contingency lines. These design errors should not be repeated now.
Backstopping IMF funding for these measures could be provided by Japan and China because of their high levels of reserves. China’s significant reserves make it one of the few countries with the resources to play a pivotal, leadership role in resolving this crisis.
Without measures to address the impact of the global liquidity crisis on emerging markets they could enter an intensifying downward spiral of financial market deleveraging, falling international reserves, sharply declining domestic and external demand, rising current account deficits, weakening fiscal positions and an intensification of recessionary pressures – all of which will eradicate the progress made during the past decade (Source: Financial Times, 27-10-08, link also see Reuters update on IMF funding).
Can ASEAN+3 act with speed?
Over the weekend ASEAN+3 states (ASEAN + China, Japan and South Korea)
reached an agreement to allow member states to pool foreign exchange reserves to help member states if they encounter problems.
Whether this can be accomplished quickly is not certain. It has taken eight years of planning and negotiations to get to this point. On Friday the news was this arrangement would be finished in June of next year (Read article). Sunday, it changed to December (Read articles #1 and #2).
The real reason for the slowness, rarely stated, seems to be difficult and sensitive "financial diplomacy" between China and Japan:
In Asia, China and Japan are vying uncooperatively for leadership. Beijing responded favourably to Korea's proposal for a regional bail-out fund, but Tokyo deferred, fearing that this would be dominated by China, given that country's immense dollar reserves. Tokyo then proposed funneling Asian reserves through the IMF, but China deferred, fearing that this initiative would be dominated by Japan, which has long participated in IMF deliberations. Financial diplomacy is evidently more difficult than in 1944 (Source: Guardian, 24-10-08, link).
Vocabulary:
vulnerable - in a situation where it could be hurt
debt rollover - allowing an old loan to continue with the same conditions
rolling over short term debt - when a short-term loan comes to an end, allowing it to continue
a currency crisis - when the value of a currency changes quickly, undermining its ability to serve as a medium of exchange or a store of value (See Wikipedia)
mother of all - the biggest one, that has ever happened
mother of all currency crises - the biggest currency crisis that has ever happened
uncontrolled depreciation of emerging-market currencies - the currencies of emerging market fall in value by very large amounts making their exports cheaper (this is what happened during tehe 1997 crisis)
pressure to erect trade barriers in the U.S. and Europe - US and Europe create tariffs to protect themselves and jobs from cheap Asian exports
withstand - resist, prevent damage and harm from
a vicious cycle - a situation with many problems that in turn cause more problems, the cycle repeats and the situation gets worse and worse
vicious cycle of unemployment and protectionism feeding on each other a la 1930s - during the Great Depression protectionism and unemployment increased at the same time thus increasing each other in the process
William Rhodes - president and CEO of Citibank, Senior Vice Chairman of Citigroup:
"Mr. Rhodes gained a reputation for international financial diplomacy in the 1980s for his leadership in helping manage the external-debt crisis that involved many developing nations and their creditors worldwide. During that period and in the 1990s he headed the advisory committees of international banks that negotiated debt-restructuring agreements for Argentina, Brazil, Mexico, Peru and Uruguay. In 1998, when The Republic of Korea experienced liquidity problems, Mr. Rhodes chaired the international bank group that negotiated the extension of short-term debt of the Korean banking system. In early 1999, at the request of the Government of Brazil, he acted as worldwide coordinator implementing the maintenance of trade and interbank lines by foreign commercial banks to Brazil." (See Wikipedia)
facilitate - help
a currency swap - a contract that commits two parties to exchange, over an agreed period, streams of interest payments denominated in different currencies, used by businesses doing business internationally to protect themselves from the risk of currencies changing value (See Wikipedia)
foreign exchange markets - markets for buying and selling currencies
interbank markets - markets for lending money between banks
a jurisdiction - an area in which a court and a system of laws has authority
a contingency - something that might happen in the future
a contingency measure, a ontingency plan - a plan to deal with something that might happen in the future
contingency funding facilities - arrangements to get money in case of a bad event happening (an emergency)
precautionary - actions taken to prevent a bad thing from happening
a line of defence - troops located at an outside point to defend (if they are defeated then other "lines of defense" further inside will continue defense)
sound - correct, reliable, sensible
sound policies - policies that are correct, reliable, and sensible
a contagion - when a disease spreads rapidly from contact with other people (See glossary)
capital account - changes in financial assets flowing into and out of a country during a period both long and short term, includes loans as well as money invested in the stock market and money markets
draw on a large pre-specified amount of resources -
factors outside its control - things that happen that it cannot control
excessive IMF conditions - the IMF placed conditions on their loans to emerging market economies that hurt their economies, economist Joseph Stiglitz has been at the forefront of this criticism
stigma attached to Y - Y makes you look bad, makes you ashamed
drew on -
a backstop - additional protection, in back
backstop IMF funding - money that will provide, if funding arrangements fail
pivotal - important for success
play a pivotal, leadership role - play a role as leader that is important for success
resolving this crisis - taking action with measures to end the crisis
leverage - borrow more money, increase ratio of debt to equity
deleverage - reduce borrowings
intensifying downward spiral of financial market deleveraging - businesses and households borrow less and less, which reduces economic acticity (buying-selling) even more, making recession worse
current account - money coming into and out of a country from imports and exports, and also from investment income and interest payments (See Wikipedia)
current account deficits - more money going out of the country than coming into the country from trade and investment income, or to simplify: imports greater than exports
progress - gradual improvement, moving closer to achieving a goal
eradicate the progress made - go backwards so that the goal is further away from being achieved
financial diplomacy - negotiations over financial arrangements between states (which are politically sensitive)
vying uncooperatively for leadership - competing to be leader of Asian (instead of cooperating as they should)
regional bail-out fund - money to help the financial systems of Asian states if they have problems
