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posted August 14, 2018

Turkey & Emerging Markets Perfect Storm Redux

The global economy is again becoming financially fragile. Financial fragility is an indicator of increasing likelihood of the eruption of a major financial instability event–i.e. stock crash, bond market implosion, housing-commercial property price deflation, sovereign debt defaults, etc. In Chapter 3 of my 2016 book, Systemic Fragility in the Global Economy, I described ‘The Emerging Markets Perfect Storm’. The chapter discussed fragility in the EMEs and explained how emerging markets economies would be destabilized and that destabilization could precipitate the next global economic contraction. The causes of the destabilization lay in US and other advanced economies raising interests rates that would in turn cause the US dollar to escalate and then emerging market currencies to plummet. That would provoke EME capital flight, to which EME central banks would respond by raising domestic interest rates that, in turn, would drive their economies into deep recession. The spreading contraction in the EMEs could thereafter transmit to the US and other advanced economies via debt contagion, stock market contraction, capital flight to US Treasury securities, a credit crunch, and general psychological ‘risk off’ investor attitudes in the advanced economies as well. That analysis, scenario and prediction was made in January 2016 in the book. The emerging Turkey crisis, as it spills over to other EMEs, and then through Italian banks to Euro banks and the US-EU real economies may now be in the early stages of development.

Global and US events delayed the process during 2015-16 during which ‘The Emerging Markets Perfect Storm’ chapter was written. Fed rates stayed low, as the US central bank retreated quickly from its threat to raise interest rates, and the dollar in turn stayed low throughout the Obama period. In the past year, however, that delayed scenario has again begun to emerge, with Fed rates now rising sharp and fast, the dollar steadily escalating, and an increasing number of EME currencies in turn crumbling and collapsing–causing capital flight, domestic inflation, recessions, inability to service external debt, and risks of contagion of the EME crises spreading to other regions of the global economy.

The current case of Turkey’s economy is at the center of this re-emerging process, its currency having plummeted 40% to the dollar just this year. (It has temporarily stabilized this week, but the decline will soon continue once again since the fundamentals have not changed).

But Turkey isn’t the only indicator of growing fragility in the global economy, Other EME currencies are also in sharp decline now at various stages: Argentina, Brazil, South Africa, Indonesia, and India. Russia’s Ruble is also deflating and China’s Yuan, the strongest currency in the EMEs, is nonetheless pushing against its lower band fixed to the dollar, within which it too has deflated by 6-10%. It has been prevented from falling further only due to China central bank’s recent intervention in global currency markets propping up the value of its currency, Yuan/Renminbi, in order to prevent further devaluation. Should Trump continue his trade war with China, however, that intervention could end and the Yuan devalue significantly further. That would ratchet up the emerging global currency war and exacerbate conditions in economies like Turkey,

Rising global financial fragility is rising due to obvious increasing contagion effects. The Turkish LIRA crisis is spilling over to other EME currencies, causing a further decline in those currencies in addition to the already significant forces driving down those currencies. Turkish dollarized debt payment obligations to Italian, EU and US banks are being noted in the business press. Italian bank debt is especially exposed, when Italian banks already sit on $500 billion in non-performing bank loans. The transmission mechanism to a broader European bank crisis might easily occur from Turkey to Italian banks to the general banking system. US banks like Citibank are also exposed to Turkish debt. Other indicators of growing potential contagion from the Turkish fallout are the global currency speculators (hedge funds, vulture investors, etc.) now plowing into short selling of the LIRA, further depressing its price, the rising interest rates on Turkey government and private bonds. The response of other EME central banks in raising their interest rates to try to stem the outflow of capital as their currencies follow the LIRA down. (Argentina being the worst case, as its central bank raises rates to 45%–thus ensuring that country’s current recession will collapse into an even more serious contraction, perhaps even depression). The first phase of the general contagion effects of the LIRA collapse have now occurred. A second ‘shoe’ will inevitably fall within weeks. Financial fragility is rising in the global economy–and will eventually impact the US economy in 2019, thus further ensuring a US recession sometime in 2019 that this writer has been predicting.

For readers interested in my 2016 analysis, ‘The Emerging Markets Perfect Storm’, (Ch. 3 of ‘Systemic Fragility’ book also reviewed on this website), that complimentary Chapter 3 follows here below: (follow my blog, jackrasmus.com, for weekly updates and analyses as the Turkey and other EME crises continue to develop):

Systemic Fragility in the Global Economy
Chapter 3 The Emerging Markets’ Perfect Storm
Copyright 2016 Jack Rasmus

An economic perfect storm is now developing offshore. Its winds of economic destruction are gaining momentum. Where it first makes landfall is unknown for now, but its ‘eye’ is clearly located in the emerging markets sector of the global economy.

Earlier the source of growth that propped up the global economy from 2010-13—preventing an otherwise likely descent into global depression in the wake of the 2008-09 economic crash—the Emerging Market Economies (EMEs) are today the focal point of a continuing global crisis that has not ended, but whose eye has only shifted from the AEs to the EMEs. Both the slowing global economy and the forces building toward yet another global financial crisis are concentrated in the EME sector.

What an accelerating decline of the EME sector, representing 52% of global GDP, means for the rest of the world economy is . . .

[continue reading via Turkey & Emerging Markets Perfect Storm Redux]