Mapping the Market
Will Emerging Markets Fall in 2012?
Jeffrey Frankel
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BERN – Emerging markets have performed amazingly well over the last seven years. In many cases, they have far outperformed the advanced industrialized countries in terms of economic growth, debt-to-GDP ratios, countercyclical fiscal policy, and assessments by ratings agencies and financial markets.
As 2012 begins, however, investors are wondering if emerging markets may be due for a correction, triggered by a new wave of “risk off” behavior. Will China experience a hard landing? Will a decline in commodity prices hit Latin America? Will the European Union’s sovereign-debt woes spread to neighbors such as Turkey?
Indeed, few believe that the rapid economic growth and high trade deficits that Turkey has experienced in recent years can be sustained. Likewise, high GDP growth rates in Brazil and Argentina over the same period could soon reverse, particularly if global commodity prices fall – not a remote prospect if the Chinese economy begins to falter or global real interest rates rise this year. China, in turn, could land hard as its real-estate bubble deflates and the country’s banks are forced to work off the bad loans.
This is not wild doom-and-gloom speculation. The World Bank has just downgraded economic forecasts for developing countries in its 2012 Global Economic Prospects, released this month. For example, Brazil’s annual GDP growth, which came to a halt in the third quarter of 2011, is forecast to reach 3.4% in 2012, less than half the 7.5% rate recorded in 2010. Reflecting a sharp slowdown in the second half of the year in India, South Asia is slowing from a torrid six years, which included 9.1% growth in 2010. Regional growth is projected to decelerate further, to 5.8%, in 2012.
Three possible lines of argument – empirical, literary, and causal, each admittedly tentative and tenuous – support the worry that emerging markets’ economic performance could suffer dramatically in 2012.
The empirical argument is simply historically based numerology: emerging-market crises seem to come in a 15-year cycle. The international debt crisis that erupted in mid-1982 began in Mexico, and then spread to the rest of Latin America and beyond. The East Asian crisis came 15 years later, hitting Thailand in mid-1997, and spreading from there to the rest of the region and beyond. We are now another 15 years down the road. So is 2012 the year for another emerging-markets crisis?
The hypothesis of regular boom-bust cycles is supported by a long-standing scholarly literature, such as the writings of the American economist Carmen Reinhart. But I would appeal to an even older source: the Old Testament – in particular, the story of Joseph, who was called upon by the Pharaoh to interpret a dream about seven fat cows followed by seven skinny cows.
Joseph prophesied that there would come seven years of plenty, with abundant harvests from an overflowing Nile, followed by seven lean years, with famine resulting from drought. His forecast turned out to be accurate. Fortunately, the Pharaoh had empowered his technocratic official (Joseph) to save grain in the seven years of plenty, building up sufficient stockpiles to save the Egyptian people from starvation during the bad years. That is a valuable lesson for today’s government officials in industrialized and developing countries alike.
For emerging markets, the first seven-year phase of plentiful capital flows occurred in 1975-1981, with the recycling of petrodollars in the form of loans to developing countries. The international debt crisis that began in Mexico in 1982 catalyzed the seven lean years, known in Latin America as the “lost decade.” The turnaround year, 1989, was marked by the first issue of Brady bonds (dollar-denominated bonds issued by Latin American countries), which helped the region to get past the crisis.
The second cycle of seven fat years was the period of record capital flows to emerging markets in 1990-1996. Following the East Asia crisis of 1997 came seven years of capital drought. The third cycle of inflows occurred in 2004-2011, persisting even through the global financial crisis. If history repeats itself, it is now time for a third “sudden stop” of capital flows to emerging markets.
Are a couple of data points and a biblical parable enough to take the hypothesis of a 15-year cycle seriously? Perhaps, if we have some sort of causal theory that could explain such periodicity to international capital flows.
Here is a possibility: 15 years is how long it takes for individual loan officers and hedge-fund traders to be promoted out of their jobs. Today’s young crop of asset pickers knows that there was a crisis in Turkey in 2001, but they did not experience it first hand. They think that perhaps this time is different.
If emerging markets crash in 2012, remember where you heard it first – in ancient Egypt.
Jeffrey Frankel is Professor of Capital Formation and Growth at Harvard University.
Copyright: Project Syndicate, 2012.
www.project-syndicate.org
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RogueBullion 12:46 22 Jan 12
I live in Hong Kong and Indonesia and it has been very clear to me why emerging markets 'recovered' so quickly from the crisis.
This QE and stimulus that have been surging out of America and other countries has not been able to generate much of a return in stagnant developed country markets.
So where did it go for yield?
It got parked in places like Indonesia where just dumping it in a bank account will get you 6% interest!!!
But why take only 6% when as a financial institution, you know that if you pile into higher risk opportunities, you get all the upside - and none fo the downside (because you will be bailed out).
So I suspect just as in the Asian Financial Crisis, what has happened is massive inflows are pouring into developing economies creating unsustainable and false prosperity.
And when the tide of money is reduced (as it has been) or goes out completely, we will see another epic crash.
I came to this conclusion after noting the Indonesian bank interest rate and also because I also noted that the Thai stock market and particularly the Baht were strengthening for absolutely no reason - in fact Thailand was having enormous internal problems yet the economy was strengthening - how could that be????
And of course there was China. Fools in Hong Kong including a World Banker - that China was making up for lost exports through domestic demand. Ya right, you just flick a switch and overnight Chinese make up for all those broke Yanks who were buying 6 big screen TVs and all the other garbage from China needed for their Mcmansions? Not likely. Of course that has proved right as data shows conumption is now a lower % of GDP in China than BEFORE the crisis. China is all about absurd levels of capital investment - particularly in property (empty cities). This is not sustainable - and like all bubbles, it will come crashing down.
I suspect the printing (US election yr) will get us through 2012 but watch out in 2013.
The world is being strangled by debt - the eyes are starting to bulge, the head is slowly turning purple....
FernandoFusterFabra 01:26 23 Jan 12
The Year of the Dragon may not be all that good for China and other merging markets. With austerity plans looming from the developed states, consumptions drops are to be expected on imports, including products proceeding from cheap manufacturers such as China. Moreover, we are about to see stricter measures and regulations on imported products as a protectionist move to back up its austerity plans and local manufacturers. Time will tell.
shahnawaz 06:48 13 Feb 12
It is strange that such an article is worth consideration. Now the students and experts would have to refer some religious docs ! Not a single solid feature of the emerging econmies could be presented in prrof of this prophecy of 21st century. It is a wish rather than analysis.
student1776 11:52 20 Jan 12
Hard to predict a big drop in commodity prices when even the worse case scenarios still are calling for significant GROWTH. It is not like the supply of commodities is increasing. Most of them are pretty finite. As Asia will be adding literally 3 BILLION people over the next two decades and their lifestyles are, on average, rising it is kind of hard to expect a lot of serious declines in commodity prices below current low levels.