George Mangus Warns of Broad Impact of Emerging Markets Turbulence

In the runup to the global financial crisis, George Magnus, who was then chief economist at UBS, was one of the most insightful commentators and was early to call how bad things might get. He’s best known for coining the term “Minsky moment” in early 2007, which he described as when “lenders become increasingly cautious or restrictive, and when it isn’t only over-leveraged structures that encounter financing difficulties . . The risks of systemic economic contraction and asset depreciation become all too vivid.”

Magnus returns and does not find much reason to be optimistic. In a comment today at the Financial Times, he discusses Turkey’s economic and political situation in some detail, and then discusses the potential for continued, widespread upheaval:

It is true that many emerging markets look stronger today than in the 1990s – they have larger currency reserves and better financial governance. At the same time they are also more vulnerable to shocks. They have lifted their share of global GDP from 40 per cent in 1997 to almost 55 per cent (on a purchasing power parity basis); now more than ever, the impact of a slowdown will be felt around the world. Most emerging economies are sustained by western export markets rather than local demand. This is a strategy that has passed its sell-by date.

Dependency on capital inflows, especially to finance rising local currency borrowing, makes these economies vulnerable to changing conditions in overseas markets. Credit cycles in China, Brazil and other countries are peaking. Commodity prices are falling from record highs….

Just as China’s ascendancy had dramatic positive consequences for emerging markets, so its slowdown can be expected to have opposite effects. The challenge of pursuing important economic reforms without eroding the power of the Communist party, and of trying to slow down fast and often weakly regulated credit creation, are China’s principal concerns now. Rising bond yields, illiquidity and instability in financial markets are the early signs.

The current crisis in emerging markets is still viewed by many as being just about Turkey. But the tequila crisis in 1994 was initially about only Mexico, the Asia crisis in 1997 about Thailand and the financial crisis of 2007-08 about US subprime lending. A crisis must make landfall somewhere. But the effects of the current storm will be felt beyond Turkey’s borders.

Magnus elaborates on some of these ideas in an interview on the RT show Boom and Bust, starting at 4:15. One of his clear and consistent messages is that the slowdown in China and efforts to constrain the shadow banking market are much bigger shocks for emerging economies than the Fed’s taper.

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  1. Swedish Lex

    When Magnus said that in 07 I thought it made total sense but the party continued for a while. Then they all panicked.
    The euro zone is on the brink of deflation except in those regions where it has already happened.
    At what point will Draghi be forced to intervene massively?

    1. vlade

      AEP says that when he met Draghi at Davos he was “wooden and unconvinced” – so I wonder what’s going on. TBH, I was quite surprised yesterday that with all that was going on in the markets EUR was holding on quite well..

  2. financial matters

    Very good interview. I think he nails it when he said QE was good at first to unblock the credit crunch but not when it went on to try and promote growth. Here I think he rightly faults a lack of government intervention on the fiscal side which left too much up to central bank monetary policy.

    Then the negative effects of QE started showing up, 1) interest rates too low which drew income out of the economy as savers lost income, 2) asset appreciation which benefitted mostly the top 1% and 3) keeping zombie banks and businesses alive.

    I also thought his take on the importance of China’s rebalancing was interesting. China has enormous reserves but can’t really spend them into its own economy as that would defeat the purpose of trying to keep the renminbi low. But it can spend them on FDI (foreign direct investment). He mentions that China’s current credit crunch/deleveraging is bringing some of that capital back into China to help with liquidity problems.

    1. Hugh

      Keeping zombie banks alive, indeed allowing them to cook the books and steal their way back to “solvency” was the whole Geithner-Bernanke foaming the runway plan. They didn’t give a rat’s *ss about burning savers, often older Americans. Geithner was particularly interested in doing anything that would jack up housing prices while Bernanke did what he could to blow a bubble in stocks.

    2. participant-observer-observed

      “Here I think he rightly faults a lack of government intervention on the fiscal side which left too much up to central bank monetary policy.”

      aka INCOMPETENT PUBLIC POLICY LEADERSHIP (Kennedy School faculty and generations of MPPs couldn’t save the country from economic auto-immune disease peddling of Geithner-Rubin clique)

      Note the intro on Chinese policy: prioritizing a domestic economy based on domestic labor (vs suckling at the teats of the naked emperor)
      American domestic economic prioritization of domestic labor needs similar “worser alternatives” to inspire a public economic policy that serves the public.
      >> another compelling reason to keep standing the ground against TPP/TTP!!

  3. Jim Haygood

    One real-time indicator of China’s economy is the price of Dr. Copper, the only metal with a PhD in economics.

    Copper peaked at $4.50/lb nearly three years ago. Now it’s around $3.25/lb. Psychologically, the key round number is $3.00/lb. If copper falls below $3.00, it’s white-knuckle time in the emerging markets. Long-term copper chart:

    1. participant-observer-observed

      So the innards of our gadget circuit boards would become worthless?

      Please tell more!

  4. Fionna Merciollis

    There’s absolutely nothing to worry about leading emerging markets such as China and India. China has changed its model of growth from export-led growth model to domestic demand enhancing model. Per Reproduction Schema, they have changed from Investment model to Consumption led growth model. Therefore, there is absolutely nothing to worry about. There will be lesser growth (hovering around 7% rather than 9%) but that’s too is enough to maintain world surplus. In addition, betterment of US economy has also helped in maintaining balance o world surplus.

    1. Walter Map

      You’re being sarcastic, aren’t you?

      The financial and economic distortions present in 2007 are mostly still in place but are disguised by an enormous increase in debt, which has merely allowed the reckoning to be delayed at the cost of ultimately making it that much worse. Since the global economy and capitalism as presently conducted are unsustainable a global economic collapse is absolutely inevitable.

      The general populations of Europe and the U.S. are in a depression and will remain so for as long as the mechanisms of excessive rent extraction by the rich are in place. Domestic demand in China and India, given the extractive policies of the wealthy in those countries, have no chance of ever replacing the ongoing reduction in consumer demand in the U.S. and Europe.

      I could go on for pages. For sure, the rich have nothing to worry about because the system is organized to ensure that they prosper, to the detriment of the rest of the population of the planet. For that matter, the rich have never had much to worry about in any financial/economic crisis going back decades except their own profligacy. For nearly everybody else prospects are dim, continue to degrade, and can only continue to degrade under the current regime. Half the population of the world has never known anything but depression, and almost certainly never will.

      1. participant-observer-observed

        “Since the global economy and capitalism as presently conducted are unsustainable a global economic collapse is absolutely inevitable.”

        Generally true; however, much of Asia does not run on hot-air: people (families, including most working poor) OWN their land, OWN their houses, OWN their cars, gold jewelry, etc., building and buying with cash. It is not yet the Potemkin avenue of the the rest of the world, all borrowed/owned by banks. In other words, the foundation is still organic substance. Even a meagre few rupees of trade per household diversified over billions of people yields a fairly robust economic ground. Labor and trade unionism is also strong, at least in Indian Railways (last i looked).

        I know Sherpas in Namche Bazar, Solukhumbu, Nepal, who bought a house in greater Boston paying cash (earned via tourist industry injecting cash in)

    2. Yves Smith Post author

      Might help if you consulted some data.

      China’s consumption share of GDP continues to fall. So much for the success of their efforts to change their economic model.

      And as we have indicated in other post, no significant economy has made this transition without going through serious dislocation.

      1. Walter Map

        I think Fionna was just being hopeful. Her claim seems unrelated to the facts:

        It’s Not So Easy For China To Just Switch To Being A Consumer Economy

        Joe McDonald, Associated Press
        Jan. 30, 2014, 4:21 AM 890 2

        China’s leaders face thicket of obstacles in turning cooling economy into consumer society

        BEIJING (AP) — Business should be picking up for Zhao Guoping, a Beijing shopkeeper, as Chinese leaders try to build a consumer society to replace a worn-out economic model based on trade and investment. But his financial struggle highlights the hurdles that ambitious effort faces.

        Squeezed by higher costs and weak sales to budget-minded shoppers, Zhao said the income from his neighborhood shop has fallen by half to 50,000 yuan ($6,000) a year.

        “Prices are rocketing up. People’s incomes can hardly catch up,” said Zhao, 38. “Daily necessities, yes, I still have to buy them. But anything I don’t necessarily need, then no.”

        The reluctance of Zhao and his customers to open their wallets wider is one of a thicket of obstacles facing communist leaders as they try to rebalance China’s economy away from reliance on investment that is losing its ability to boost growth.

        Combined with an export boom, a flood of spending on new factories, highways and other assets powered the past decade of explosive growth. That helped China rebound quickly from the 2008 global crisis. But it was paid for with a surge in borrowing that economists warn looks like debt booms in other developing countries that spiraled into financial crises. [Italics mine]

        Policy claims notwithstanding, there was never any reason to suspect that the wealthy in China – or any other country – would have any inclination to allow the general population to prosper if there was any way to prevent it. Why share the wealth when they can have it all?

        All for ourselves, and nothing for other people, seems, in every age of the world, to have been the vile maxim of the masters of mankind.

        – Adam Smith

    3. judabomber

      Read Magnus’ book Uprising, it is a well-researched read and you might find yourself changing your view as he lays out the facts for you.

      And economic rebalancing issues aside…in the case of China as Magnus mentions and as some others know, the size of the working age population is declining. Go to the UN population database and pull the old-age dependency ratio for Japan and China. Then lag the Japanese data 20 years and see how the two series correlate. Think changes to the one child policy will move the goal posts? Not likely to happen in your or my lifetime. The ultimate contraceptive is wealth and education…which is on the rise among Chinese women these days.

  5. sleeper

    Please folks this is just the latest market blip caused by high speed computerized trading.
    This trading thrives during market swings real or not.
    As always any blip is ascribed to some nebulous unverifiable condition.

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