Synchronised shocks
THERE IS no doubt that the coronavirus is having a devastating impact on the global economy. Unemployment has soared as citizens have been ordered to stay at home. Goldman Sachs predicts that the United States economy will shrink 34 per cent in the second quarter, and the unemployment rate will spike above 15 per cent.
Millions of small businesses have been wiped out, and governments around the world have been forced to provide unprecedented amounts of relief aid in order to preserve social order.
Heterodox concepts that had been percolating among academics and policy wonks, such as the minimum living wage, helicopter money, central bank asset purchases and modern monetary theory, MMT, have been rushed into service.
Classical beliefs in fiscal and monetary discipline have gone up in smoke. The historical collapse in the equity market, as well as the abysmally low Treasury yields portends what lies ahead. While developed countries have resources to help confront the downturn, it will be more difficult for many developing countries.
The collapse in domestic economic activity, evaporation in tourism, drop in commodity prices, and loss of remittance income will be devastating for many countries. Some commentators declare that such a synchronised shock is without precedent, and that we do not have a map to guide us through what lies ahead. However, that is not true.
The emerging markets, particularly
Latin America, have repeatedly suffered synchronised shocks for which they were not prepared. World
War I and II, the Great Depression, the oil shocks of the 1970s, the 9/11 terrorist attacks, and the financial crisis of 2008 are just a few examples. Moreover, the best example of the current situation could be the monetary tightening of 1982.
The 1970s were a period of enormous liquidity. The spike in oil prices left many oil-producing countries haemorrhaging with cash, and they deposited it en masse at the large money-centre banks. Not knowing what to do with the deposits, the banks channelled much if it into the emerging market countries.
This was very similar to what occurred during the last decade, when expansive monetary policies across the developed world, in the aftermath of the 2008 financial crisis, found trillions of dollars moving into the emerging markets in search for yield. Countries that had never had access to the international capital markets in Central Asia, Africa and South America were the recipients of billions of dollars in capital inflows.
Investors blindly lent to serial defaulters, such as Argentina, Greece and Ecuador. Unfortunately, the party came to a sudden stop in 1982, when US Federal Reserve Chairman Paul Volcker decided to raise interest rates to 18 per cent. Overnight, the flow of capital into the emerging markets reversed, and governments were left scrambling over what to do.
Economists call this a suddenstop situation, when emerging market governments are faced with an unexpected shock and are forced to rely on heterodox policies, such as massive devaluations and large fiscal deficits. These measures pushed many countries into high or hyperinflation.
At first, the multilateral lending agencies considered the situation a liquidity problem – which was kind of true. The economies were in relatively good shape, but their access to external capital had suddenly stopped.
The International Monetary Fund, IMF, World Bank and the various development banks, such as the Inter-American Development Bank,
IDB, were enlisted to provide relief through a programme known as the
Baker Plan. The problem was that their combined resources were woefully low. As a result, the debt crisis lingered on for another seven years, until the large creditors finally acceded to a coordinated debt-relief plan, which became known as the Brady Plan.
Like three decades ago, the emerging market countries were in relatively good shape. With the exception of Venezuela, Argentina and Ecuador, most emerging market countries had healthy economies, with low levels of debt and good access to the international capital markets. However, the severity of the coronavirus economic downturn has devastated most of them. It has also shut down the capital markets.
Like three decades ago, the multilateral lending agencies have expressed their support. Yet, like three decades ago, their resources are woefully low. Much of the IMF’s balance sheet is tied up in Argentina, with no prospects to get it out in the near term. IMF Managing Director Kristalina Georgieva has mentioned her willingness to help countries in need, but the funds are just not there.
Perhaps the low interest rate environment could motivate some investors to channel funds into the better-rated countries. Yet, many may be more inclined to wait to see their true state of affairs, before committing. Nevertheless, there have been plenty of examples of sudden stops for the emerging markets. The problem is that they never have a happy ending.
■ Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC. wmolano@bcpsecurities.com.