Christine Lagarde, head of the International Monetary Fund (IMF), has been issuing warnings this week about the potential troubles looming in emerging market nations.
Ms. Lagarde’s comments about the situation have grown more dramatic over recent weeks. She said on Wednesday, “It’s not just clouds on the horizon that we see, but some of the clouds have started opening up, and it’s a bit more than a drizzle.”
Argentina has been granted the IMF’s “biggest bailout package in history,” coming in at $57 billion loan.
The IMF is now considering a request from Pakistan for a loan... estimated to be at $7 billion.
Turkey has been on the brink of a collapse... and the list goes on, including South Africa and Venezuela. Even Indonesia has experienced a substantial drop in its rupiah against the dollar in recent weeks. The rupiah is now at a 20-year low against the US dollar.
And the current disequilibrium situation is not of recent origin.
For one, the US dollar is the dominant currency in the world, whether or not the current government in the United States wants it to be. Being the dominant currency in the world means that many nations with lesser credit standing have issued government debt that is denominated in US dollars.
This, however, makes these countries more susceptible to what is happening to the dollar... and also more susceptible to the stance of monetary policy in the United States and the strength of US financial markets.
I have written about this situation earlier and described some of the dynamics of the environment. At present, “IMF officials have repeatedly said they do not see any evidence of contagion in Ems and investors are differentiating between countries that had made policy blunders and those that have been more virtuous.”
“The fear is nonetheless that Argentina and Pakistan are only beginning, and over the coming months the fund may be forced to consider lending to other countries facing problems, including depreciating currencies, rising fiscal gaps, and debt servicing challenges exacerbated by rising interest rates.”
The focus, therefore, is mirrored back to the United States and what is the perceived future path of monetary policy to be set by the Federal Reserve.
Right now, the United States' situation, on the surface, is good. The real economy is growing at an acceptable pace, the unemployment rate is at a low not hit since 1969, and profits seem to be doing well.
Given this optimistic outlook, officials at the Federal Reserve have signaled that the Fed will raise its policy rate of interest one more time this year and follow this up with three more increases next year. Furthermore, Fed officials want to continue to reduce the size of its securities portfolio and bring it back to a “more normal” size.
The combination of all these factors - the strong economy, high employment, along with the Fed’s confidence in continuing to raise its policy rate of interest - has spilled over into the longer-term interest rates, as the yield on the 10-year US Treasury note has popped through the 3.00 percent ceiling it had failed to exceed for several years and has even jumped up to 3.15 percent, before returning to just under 3.15 percent at the close of business on Thursday.
All of this has been absorbed by investors and, as a result, has led to a decline in the currencies of several of these nations and in their stock markets and a rise in their government bond yields. This is why Ms. Lagarde and others at the IMF are getting edgy.
“For more than a year,” Ms. Lagarde “had been warning officials in the developing world to set up buffers in the event of new trouble in the markets.” Now, she seems to believe that the “moment” has arrived.
The financial stress being faced by emerging market nations has dominated the recent meeting of IMF and World Bank officials. Memories were revived of financial disturbances in the 1990s and the many interventions that had to be performed at that time. They were not good memories.
Unfortunately, these concerns are being raised at a time when the IMF is facing a little uncertainty of its own future. Although the United States has supported the bailout of Argentina, the current administration in Washington, D.C., has not indicated that it will financially support the IMF as it has in the past. Support could be offered only on a case-by-case basis.
Furthermore, there is uncertainty about the looming trade war between the United States and China. An acceleration in this situation could have major impacts on the specific situations that might evolve out of market conflicts.
Then, there are other little disagreements, like the withdrawal of the United States from the Iran nuclear deal, which have implications for the possible destabilization of the global economy.
The uncertainty in all these cases has to do with the position of the United States in each situation. In the past, the intent of the United States was much more obvious than it is now.
So, where do we go from here?
Investors have been increasingly worried about where the shock might come in the world to disrupt the global financial markets, global trade, and the nine-year economic expansion of the United States.
It appears as if the condition of emerging market nations might be one thing that could create another adjustment in economic conditions throughout the world. If the leaders at the IMF seem to be that worried about a possible disturbance coming from this area, then we should keep an eye out for what might take place there, as well. There are others we must keep an eye on too, of course, but this one seems to have a little more “bubble” to it at the present time.
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