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Emerging Markets Learned Their Lesson

Posted by Larry Doyle on October 27, 2009 9:50 AM |

Are emerging markets now the teacher instead of the student? As such, are recent developments in select emerging markets signaling a turn in our markets? Let’s look closer and navigate this corner of our global economic landscape.

Recall that the global market turmoil of 1998 was precipitated by the devaluation of the Russian ruble. As that domino fell, global markets and economies reacted violently. Here in the United States, the meltdown in the broad market caused the failure of the hedge fund Long Term Capital Management. In hindsight, many believe the Fed-orchestrated takeover of LTCM by Wall Street banks set the table for the massive increase in leverage on Wall Street which led to the current crisis. However, what were the lessons learned in the emerging markets from the 1998 crisis?

Many emerging markets were effectively forced to take support from the IMF as a result of the 1998 economic meltdown. The IMF support came with many strings attached. Those strings were tied to strict controls and onerous burdens imposed on many emerging market governments. Having been forced to live under these burdens once, these governments do not want a visit from the IMF again. As such, they have done a much better job at getting their fiscal houses in order and keeping them in order. Many other governments primarily in the Western hemisphere, including the United States, should have done the same.

How is this playing out currently?

A number of emerging markets continue to attract significant amounts of capital. That flow of capital is driving the economies and the currencies across a wide swath of the emerging economies. Given the flow of capital, we are now witnessing certain emerging economies looking to withdraw their own government stimulus. Why? Concerns of overheating the economy leading to a serious bout of inflation.

Bloomberg highlights these developments this morning in writing, India Central Bank Begins Exit From Monetary Stimulus:

India’s central bank took the first step toward withdrawing its record monetary stimulus as inflation pressures build, ordering lenders to keep more cash in government bonds.

“It may be appropriate to sequence the ‘exit’ in a calibrated way,” Governor Duvvuri Subbarao said today after increasing the statutory liquidity ratio to 25 percent from 24 percent and raising the inflation forecast. The central bank kept benchmark policy rates unchanged, while maintaining its economic growth forecast of 6 percent “with an upward bias.”

Stocks fell the most in two months after the statement spurred speculation the Reserve Bank of India will boost borrowing costs by year-end, eroding corporate profits. Today’s shift also signals intensifying global concern about consumer and asset-price increases, with Norway tomorrow forecast to follow Australia in raising rates this month.

As these select emerging economies boost their borrowing costs, it will actually serve to further support their currencies and in turn attract even more capital. That capital flow will likely force other developed economies, including ours, to maintain government programs and quantitative easing longer than our wizards in Washington may otherwise want.

I believe the pain experienced by emerging economies ten years ago has been a lesson well learned and is benefiting them now.

In assessing the United States, I believe the Greatest Generation, which developed from The Great Depression, learned many lessons as well. Those lessons include thrift, sacrifice, love of family and nation, and many more.

What happened to those lessons? Will our country learn from this current crisis? Will future generations benefit? Do we have the collective will and courage?

What do you think?


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