Shocks in the main financial centers and
propagation to the emerging economies: more
questions than answers.
Affonso Celso Pastore
Bretton Woods II : a stable equilibrium?
• China (countries pegging their currencies to the dollar) X EUA: It
was assumed that the equilibrium was stable. China with large
savings and current account surpluses exported deflation to the
US that as a consequence could sustain a very low real interest
rate, very high consumption and current account deficits that were
financed by the Chinese’s purchases of Treasury bonds.
• low interest rates for a long time period lead to bubbles (real state,
commodities, financial assets), to increasing financial system
leverage, and low transparency hiding risks.
• Starting in August 2007 a banking crisis of large proportions (truly
a Pandora box) superposed to the burst of the real state bubble,
also affecting Europe and Japan, pulverizing the possibility of a
“decoupling”, and bringing fears of a strong world economic
deceleration or even recession.
Role of emerging economies
• In the past emerging markets used to shake the world. Fixed
exchange rates coupled with currency mismatches, current account
deficits, fiscal deficits, dolarization of the public debt were at the
base of the South East Asia, Russia, Brazil crisis, among others.
Contagion was frequent.
• This picture has changed. In most of the emerging economies sound
economic policies were put in place. Vulnerability to external shocks
was reduced by the improvements in fiscal policies, inflation
targeting, reduction of external liabilities, increases in reserves.
More recently they benefited from upward cycle in commodity
prices.
• Important emerging economies keep posting high growth rates,
leading to the “decoupling hypothesis”.
The banking crisis and FED’s reaction
• Starting in August 2007 a banking crisis of large proportions (truly a
Pandora box) superposed to the burst of the real state bubble, also
affecting Europe and Japan, increasing the probability of a strong
world economic deceleration or even recession.
• The risk of a systemic crisis prompted the Federal Reserve to
aggressively reduce interest rate. Lessons from the 1929 depression
commanded the reaction. Several other Central Banks (BoE, BCE,
Bank of Canada) injected significant liquidity volumes.
Where do we stand?
In the very beginning, the optimistic reading was that the “correction”
would be small, since the aggressive interest rate reduction would
minimize bank’s losses, and institutions would be capitalized by the
money coming from the private sector, sovereign wealth funds, etc.
Currently, this understanding is clearly be too optimistic.
The flavor in the US is given by some statements:
– In the near future a large bank may go under (Kenneth Rogoff)
– We are in the midst of the worst financial crisis since World War II, and there is
enormous uncertainty about where we stand at the moment (Stanley Fischer).
– It is amazing a year later how much is still unresolved (Alan Blinder).
There are other big “surprises coming out of the Pandora Box –
Freddie Mac and Fannie Mae
Where do we stand?
• The credit crunch – the main responsible for the economic deceleration –
goes on.
• To that we have to add: the real state crisis; the effects of high petroleum
prices (automobile industry, air transportation).
• But inflation in the US is high and growing, and the FED cannot further
reduce the interest rate. There are concerns that maybe the easing has
gone too far.
• There is strong deceleration in Europe and Asia.
Can the emerging economies sustain higher world
economic growth?
• Over the past five years emerging markets have accounted for
between one quarter and one half of global growth. They also have
weathered well the recent global financial problems. Through
growing financial and trade links have helped keep advanced
economies from slowing down.
• But inflation is a problem.
Inflation in emerging markets
Inflation in emerging markets
2007 2008f 2009f
Asia 4.2 7.3 4.9
India 4.5 10.0 6.0
Indonesia 6.4 10.2 8.5
Philippines 2.8 10.4 7.7
Sri Lanka 15.8 20.5 15.0
Vietnam 8.4 24.3 14.0
Europe 7.3 11.2 9.5
Romania 4.8 8.0 6.0
Russia 9.0 14.2 12.8
Turkey 8.8 10.8 9.0
Ukraine 12.8 25.2 16.4
Africa/Mideast/Eurasia 7.0 11.8 6.6
Egypt 9.5 19.4 8.7
Kazakhstan 10.8 17.7 9.5
Lebanon 5.7 10.2 4.6
Pakistan 12.0 21.9 5.4
Qatar 13.8 14.0 11.5
South Africa 7.2 11.5 6.4
United Arab Emirates 11.1 10.5 9.2
Total 5.3 8.7 6.6
What is behind such inflation?
• In the emerging markets we have economic growth stronger than
potential, with inflation targeting central banks posting negative real
interest rates or accommodating such shocks.
• The US has cut interest rates substantially. But for the emerging
markets pegging their currencies to the dollar this is also their
domestic interest rate. Such emerging markets have eased their
monetary policies at the same time their economies have continued
to grow fast.
Despite recent declines in petroleum and metals prices (two
graphs in the upper row), CRB-total and food prices (two on the
bottom row) are still very high and probably will tend to remain
so.
160 160
140
140 Mat. Prima p/Industria
Metais
120
120
100
100
80
80
60
60 40
1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 20
40
2007 2008 2002 2003 2004 2005 2006 2007 2008
150 180
140
160
130
120 140
110
120
100
90 100
80
80
70
60 60
1994 1996 1998 2000 2002 2004 2006 2008 2002 2003 2004 2005 2006 2007 2008
Equity prices indicate pessimism concerning growth
240 240
base do índice - jan/2006 = 100 base do índice - jan/2006 = 100
220 220
Brasil
200 Brasil Argentina
Nasdaq 200 Chile
Dow Jones México
180
S&P 500 180
Nikkei
160 Xeta-Dax
160
140
140
120
120
100
80 100
1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 10 1112 1 2 3 4 5 6 7
60 80 2008
2006 2007 2008 2006 2007
600 150
base do índice - jan/2006 = 100 base do índice - jan/2006 = 100
140
500
China Nova Zelândia
Coréia do Sul 130 Turquia
Indonésia
400
Índia 120
300 110
100
200
90
100
80
1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7
0 2008
70 2008
2006 2007 2006 2007
Probable scenario
• Further deceleration in the US (the banking turbulence is still going
on, and the FED is lacking ammunition). Slowdown larger than
expected in Europe. Stronger growth in emerging markets, but
inflation is high and claims for a slowdown.
• The world economy will probably go through a larger than expected
deceleration.
Thank you