Originally appeared at Deutsche-wirtschafts-nachrichten, translated by Albu Dumitru exclusively for SouthFront
The commodity shock could soon generate new problems for the German export economy. IMF forecasts a crisis for the world emergent countries, however has no solution on it. Germany must urgently prepare for this situation.
“Chief of IMF Christine Lagarde attending a meeting organized by IMF and World Bank in Lima, warning about a new crisis in the world emergent countries.”
On sanity and insanity of international economical debates there can be disputes. This offers always a platform for establishing contacts, to snoop around a little for the tendency of global winds and gives two or three core messages for the domestic audience.
This year in Lima, where the works took place, the things were the same, it appears nothing could change in the debates on the monetary funds and World Bank, just the place: Latin America, the first time after 50 years.
Still this occasion would have to be or better had to be of a more serious nature. The world economy is in a strange period, a strange silence of an odd silence and hectic rush before a possible serious storm.
With balanced words and like a choir of alerters of IMF as well has seriously warned about the risk of stability in connection with attenuation of growth in China and the crisis in the emergent countries. The economists of the funds speak in this respect about three challenges in report concerning financial stability: the process of coming to terms with the past and the process of normalization in the advanced industrialized countries, a substantial attenuation of growth in China with effects over the emergent industrialized countries and a risk on the market liquidities.
Concerning the advanced industrialized countries it is suggested by the funds a slowly normalization of the money policy in USA and of the situation in the emergent countries. A strengthening of financial architecture in Europe is in the fore. On the one hand this is related to Eurozone’s function as a unique currency area, on the other hand to a quick solution for the non-performant credits offered by banks. In all it’s about of the progress of an expansive policy and where is possible, of an expansive financial policy. The emergent countries consider the funds being in a recession phase of credit circuit..
The economic growth decreases after a unprecedented boom of credits. The declining prices on commodities and the risk of a contraction of home credits reduced the receipts of the companies in domestic economy and foreign trade. The currencies in decline increases conversely the debts accumulated especially in US dollar currency. The banks of emergent countries are traditionally protected by solid deposits. However, because of preceding expansion of credits, these banks find also in an aggravated situation. They have reached to a relation between credits and deposits that establish regulatory barriers or they can make them reasonable.
The costs of financing produce no more liabilities – therefore the upcoming credit contraction will be accompanied by failure rates with an increasing tendency. Based on this exposure of banks and non financial corporations the borrowing costs will be more difficult. The both are favourable to produce shocks.
That leads to a third risk, the risk of a schlock and the subsequently effects on financial market. The economists of IMF perceive here a substantial, hidden risk of liquidities for the markets. A shock can, according to this analyse, leads to the strengthening of market fluctuation that could lessen the trust in the economy dramatically. Here it’s about of a complex phenomenon. Interest rates are one of these. Normalizing of money policy by the issue banks can cause abruptly changes in return of capital. The low interest rates have led to a compression of risk premiums. The traditional institution investors, like insurances, pension funds and funds turned out to crisis investments to augment because of the low interest rates and investments grew excessively in risky obligations.
Even the classic retail funds were exposed there and contain withdrawal risks. That is a form of ALM risk. Another phenomenon is the purchase of obligations by the emission banks that have strong reduced the liquidities on markets. This is connected to the fact that the banks because of underlying obligations hold any or only small unsecured trading portfolio.
In case of a crisis there is a short of liquidities providers. The report of IMF in the case of stability-report is interesting, however one talk here about the essence problem or explains the problem not enough. This is more clear explained by the economist Carmen Reinhart (this time is different; eight centuries of financial follies, we are the witnesses of a classic crisis of emergent countries that is prepared and announced). All the phenomena are present here: very accentuated of the past credits expansion a diminution of economy growth and fail of exports, liquidation of boom on assets’ price an ascendant trade balance and fiscal deficit, a rapid growth of debts, thinning or a reversal of the import of capital. That must especially cited are the foreign currencies and hidden financial leverage effects that statistically are included nowhere. Lot of infrastructure projects from emergent countries, especially in mining, energy and transport areas, are financed by the development banks from China. These credits are on a dollar basis offered, but there are not included in the data bank of BIZ or World Bank.
Exactly like swap transactions and the short term commercial credits. According to their estimations indebtedness of emergent countries are clearly higher than banks data and is exposed to supplementary high currencies risks.
The crisis of emergent countries can take the same dimensions as the former crisis. The fall of the commodity prices is historical and can be compared only with that from the 1980 years.
The following graphics shows the development of commodities price on a long term. The collapse of 2011/2013 has bigger dimensions than that of beginning and middle of the 1980 year. Two effects can be noticed at the decline of commodities price: the effect of change describes the immediate actions on the financial market, on wrong foot, and false actors, sectors, etc… By such a fall appear tensions, there are wrong positioned actors with too much financial leverage or indebtedness like Glencore or other suppliers of commodities. This effect that appeared so dramatically in a short term is not the most important. A correction of the downward trend can cause a relaxation of the financial markets. The second effect is the level effect. If the price of commodities on long term doesn’t reach a much deeper level, then that is much weightier. As on short term exist indeed financial leverages, but there is also a buffer: the currency reserves of the countries exporting commodities the liquidities of the companies and the access to a bank credit based on generally admitted limits.
Back in time there are these two effects that allows the currency reserves to shrink and the liquidity to run dry. There is no access at credits of banks any more. Of course, decisive is naturally at what level the commodities price is finally. The present level is standing in essence higher than that of 1990. If the price of commodities falls obviously at lower levels, then that will be dramatically for lot of countries, sectors and companies.
The effect of acutely declining prices will be accentuated by the fact that in lot of countries where the export of raw materials that dominates the exports, principally by the extreme increase of the price on the raw materials. The following graphic shows the quota of the raw material in the total export to economic regions. Unfortunately it happens that in most of emergent countries the quota of raw material dominate the export of raw materials or even monopolizes it.
This is valid for Eurasia, Middle East, Africa, Latin America. In this respect, it almost doesn’t happen that these countries register important progresses in the foreign trade. What is new is the volume of private sectors in the emergent countries and the enterprises like households as well. At the beginning of the crisis the state was principally indebtedness. Today this image one composed. There are countries with a reduced of debts of state and some with a high level of debts. Therefore, one must make a distinction between the various countries and groups of countries. But more prevalent is the fact that the banks when faced with a currency inflow in the period of the high prices at raw materials in years 2006-2014 the internal credits were granted preponderantly to enterprises and households. These credits based directly and indirectly on the high exchange rate of exports and therefore were directed to dynamic of growth.
Another feature concerning the earlier phase of crisis in emergent countries is their regional interlinkage. During the crisis of 1980 years the emergent countries of Latin America closed economies without external contacts with a model substituting the import. In addition they had individualized sectors which made exports that first of all produced for the global market of industrialised countries. Today lot of emergent counties are interconnected on a regional basis – in Eurasia, the south east Asia region that finds all around China and secondary around Japan, Latin America and Africa. Serious signs of collapse in individual exposed countries happened in all regional area. Besides helps not either, even if the exports are diversified. In Asia lot of countries export preponderantly industrial and intermediate goods. Though they feel tough the recession of the Chinese import and export and obviously exposed themselves to a setback of exports. Eventually the leeway at the central banks limited. Unlike the central banks of most industrialized countries lot of emergent countries’ central banks don’t have the same instruments. An important part of the emergent countries find de facto in a dollar standard. They have no mean to reduce the interest – they are already at zero or at vicinity of zero. These countries can not be easy devaluated, as their passive is based on dollar. Another part can indeed to devaluate the currency and so the effects of trade balance of the home currency mitigates or compensates. If the debts find abroad you can count on a real increase of your country’s abroad debt. Especially on the basis that those currencies are already drastically reported to dollar. Besides that the currency must often with high interests stabilized that stalls the domestic demand. This has obviously consequences for the unattended credits, the obtainability of credit and for refinancing of the existent debts. Generally this means that the banks and investors charge the high risks not only in China but in the emergent countries as well. They have assets that must be considered, reported to not banking companies and the banks association, as risky. These risks are first of all specific to countries and sectors. And that can rapidly extending. What today a sufficient or even solid capital seems, can have in the emergent countries at a chain reaction, fatal consequences for the loan losses the own capital cover and the capacity to create domestic capital in the emergent countries.
The main recommendations of the IMF for the emergent countries are the market-driven of the structural reforms consolidation of inland revenue and the devaluation. This a standard receipt. Nobody thinks seriously that the middle and long term of the most important structural reforms can be carried out. To diversify an extreme dependence on raw materials, today, in a sector dependent of raw materials? This would be the necessary structural reforms , though nobody believes seriously in construction of a huge export capacity outside of a sector not dependently of raw materials. And only then. The present debts are connected especially with the sector of raw materials. The reality is that an important part of emergent countries depend in the incoming years for better or worse of the price on raw materials. Structural reforms on short term are not. Such words are just a divagation from the hard austerity. Individually this can have sense, but in system there is a receipt for disasters. But then with harder effects for the domestic failing demands.
Another reality is that lot these countries depend for better or worse of China.
That applies for lot Asian countries and in all applies for lot of raw materials exporters. For local plan this is valid for lot of Asian countries and generally is valid for raw materials exporters. In official jargon, China must build a growth model oriented from the investments driven to exports and imports to a model of economic growth or even a slower economic growth. Seven per cent of economic growth or lower than seven could be still a strong growth. This sounds good but doesn’t solve the essence of matter. As most of emergent countries depend not on China economic growth in aggregate but on China’s construction growth. Cooper, aluminium and other metals partially coal for producing steel. The truth about this activity of construction is that she musts always be at high levels and probably considerably leads downwards.
A further reality concerns the matter of energy. The energy is the most important raw material even more important then metal industry. The energy sector is the core of dependency of raw materials for lot of emergent countries. Important is the factor that the energy demand brings high incomes and has flexible prices. Important is the fact that the global demand of energy is dictated not only by the industrialised countries but by the emergent countries as well. China has stocked his strategic oil reserves at tough prices. Though the transition from demand to offer can become inoperative on long term. Through more regulations and innovations should the use of energy in industrialised countries reduced and untied further from the economic growth.
On the supply side, is a reversed tough case of the marginal costs of production avoided. Even the costs for a new energy are under pressure, for photovoltaic, wind and thermal energy. Conversely increases the demands concerning the environmental compatibility and subsequently the costs production for coal. An important aspect of credit in the emergent countries that should be assigned to private sector is the infrastructures, the energy installations the mines and transport capacities for these sectors. The consists in the fact that these credits are wrong invested and these installations are not useful.
In what concerns the market of liquidities as well, should the analyse of the IMF’s economists some completions. The most important risk of liquidity result from the fact that huge volumes of the financial market emanate principally from short term transactions conceived on algorithmic trade model. These are useful to price differences and care as such within some days for a probably very high liquidity. The big trade models can’t without further millions of transactions per day to be produced. They hardly detain a nightly position. When a really panic master the market should no adverse party exist.
The great risk consists with other words that since 2009 the policy on banknotes and banks regulations involuntary and can have high counterproductive consequence. A divergence between the necessary valuation adjustment and liquidity. Basel 3rd has obliged the banks to drive down drastically their accounting registers. By this one wanted to put tight barriers to the private trade. However this has reduced the liquidities for the customer trading. The policy of zero interest of the 1970 years and the quantitative relaxation of the money policy through FED and other emission banks have led the institutional investors and pension funds to an investment crisis They can not reach any longer with risk of losses assets their guaranty cover rates through this they placed in a high risky investment like corporate bonds, credits at high rate interest actions and investments on the financial market and they should be limited. The expansive money policy through risk premiums and the pressure over the rates of return have compressed the financial markets and further the real economy.
This has consequences nowadays and the pressure over the rates of return. They were not and are not the bonds and actions as assets classes appreciated in a historical comparison overestimated.
Lot of investments that are financed on a short middle and long term, are not at all viable or become in industrialised and emergent countries. Such a thing in the industry of shale gas, but are practically distributed in all sectors. Lot of companies some of them powerful became indebted and costly takeovers, the buyback of the own actions or to finance the payment of dividends. These high evaluation correspond statistical with a huge volume of transactions. These generally sector concentrated blazes are total different as in 2008/2009 there were no good, nor market liquidity. And total different to 2008/2009 when there are no longer the classical tools of the money policy as well like the drastical fall of interest in USA and Europe able to absorb the shocks in this situation appear the worst scenarios and trade recommendations in anticipation to those not the last, that has brought along this mess. The most simple is still the management of actions and the bonds, for which the “bad news” as usually are “good news”. In the crash of market of 24th August this year put have unseen hands the Stock Exchange in New York of S&P features at 3-4 per cent in growth. This helps an expected reduced negative spiral to hint on a short term. But when this provokes a dramatic deterioration of the economical situation in emergent countries, China included, a chain of credit events, bankruptcies, payment holiday, then such interventions cannot help any longer. The usual recommendations of the financial funds (oriented to structural reforms, devaluations, etc) are not balanced and without effect. The economic policy and the companies as well, should prepare for further scenarios and work in this respect. The thinkers of the worst cases have elaborated three trade alternatives: negative interests, reduction or interdiction of cash payment and the system wide “Bail in”. Enough chief economists of the famous central banks like Bank of England and ministry of finance as well, belong to these precursors. This is a cock tail belonging to same people that have long time defended or implemented.