Felix Salmon

Who’s to blame for the emerging-market crisis?

Felix Salmon
Feb 1, 2014 23:23 UTC

Paul Krugman and Dani Rodrik are out with dueling op-eds (the latter written with Arvind Subramanian) on the subject of the latest bout of financial-market craziness in places like Argentina and Turkey. Both men have been following emerging-market crises for decades; both indeed, are world-class experts on such episodes. What’s more, both economists have a broadly left-liberal worldview: there’s no deep ideological or philosophical rift here. And yet the two seem diametrically opposed.

Here’s Krugman:

Turkey isn’t really the problem; neither are South Africa, Russia, Hungary, India, and whoever else is getting hit right now. The real problem is that the world’s wealthy economies — the United States, the euro area, and smaller players, too — have failed to deal with their own underlying weaknesses.

And here’s Rodrik:

Emerging markets aren’t hapless and undeserved victims; for the most part they are simply reaping what they sowed…

The fact is that the emerging economies’ troubles are domestically generated problems and not the fault of foreigners. The complaint of emerging-market countries seems a classic case of blaming outsiders for choices and actions that have been predominantly domestic.

Take a step back, and you’ll find a certain amount of agreement: both Krugman and Rodrik would accept that a large part of the story here is that the Fed’s QE program caused enormous amounts of cash to flow into the world’s emerging markets, thereby helping to inflate the markets which are currently crashing. What goes down must have gone up — and it’s easy to see where the inflows came from.

That said, neither Krugman nor Rodrik is blaming the Fed for causing the emerging-market bubble in the first place. The Fed had a (domestic) job to do, and did it; QE was part of that job, and the Fed simply can’t worry too much about potential unintended consequences on the other side of the planet when it’s setting US monetary policy.

The stories being told by both Krugman and Rodrik are consistent, then, with the “taper tantrum” theory of the current emerging-market crisis. Basically, emerging-market economies have become reliant on the constant flow of very cheap dollars being printed by the Fed; now that QE is coming to an end, they’re finding themselves in a real pickle.

Here, however, the two narratives diverge. Krugman, if I’m reading him right, is saying that if only US economic policy had worked better, we would have a much more vibrant economy, throwing off enormous amounts of cash which would more than make up for the taper. Employed Americans, along with fast-growing US companies, would naturally look to invest their money abroad, and the flows to emerging markets would remain healthy, thereby avoiding a crisis. Instead, we have too few employed Americans, we have overly cautious US companies, and the markets have come to the collective (and self-fulfilling) decision that the end of QE will mean the end of substantially all capital flows to emerging markets. The result is a “sudden stop” — and all sudden stops are extremely painful.

Rodrik, on the other hand, says that the current crisis is the emerging markets’ own fault, for opening themselves up to fickle and volatile capital flows in the first place. Worse, whenever these economies run into difficulty, they tend to respond by becoming even more open to international capital flows. This is a story which is bound to end in tears, no matter what the Fed does.

The two narratives aren’t entirely contradictory, but ultimately Rodrik’s is more important, and more correct. Sure, a healthier US economy might well have kept the money flowing to emerging markets for a bit longer. But as Krugman himself demonstrates, sudden stops in emerging markets can happen in any number of US economic environments, and for any number of reasons. The trick to preventing sudden stops isn’t to keep the money flowing: the trick to preventing sudden stops is to not make yourself susceptible to them in the first place. Here’s Rodrik:

Over the last five years in India, every episode of rupee pressure has provoked a relaxation of regulations on foreign inflows, which has rendered the economy vulnerable to the next rupee shock, which, in turn, provokes the next liberalization and so on. In Turkey, policy makers spun a tale of invulnerability to shocks and contagion even as the economy’s growth was driven by a flood of short-term capital inflows. China provides an instructive contrast. China has chosen to insulate itself from foreign capital and has correspondingly been less affected by the vagaries of Fed actions and the fickleness of foreign finance. Chinese policies aren’t blameless, but their economic insulation has afforded them the luxury of being the recipient of complaints rather than the distributor.

With the taper ending, we’re beginning to see markets start to become rather more discerning than they have been in recent years. No longer will money simply flow to anything and everything, be it gold or Turkish lira; instead, we’re beginning to see the return of volatility. Sometimes, as in the case of this week’s Facebook earnings report, that volatility is welcome. And sometimes, as we’re seeing in emerging markets, it isn’t — especially when the volatility looks as though it’s more a self-fulfilling caprice than a rational reaction to economic fundamentals.

Still, as Rodrik knows better than anybody, Turkey has real political and economic problems of its own: you don’t need to look to the Fed to find reasons for the current sell-off. Sometimes, small open economies are the blameless victims of forces outside their own control. This is not one of those times. They knew what they were doing, when they allowed the Fed’s liquidity to flood their economies. One day, the tide was going to start going out. That day has now arrived.


Two morons duking it out without understanding the obvious trigger. A trigger that has been discussed a great deal in the financial media. It is the taper and reduction of cheap Fed liquidity that is pulling money out of these emerging markets. It was predicted this would happen and it is happening. That’s not to say the emerging markets wouldn’t be having problems anyway but we’re seeing concerted chaos in these emerging markets because of the Fed’s QE and zero interest rate policies. Policies that chumps like Krugman support.

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Chart of the day: When emerging markets trade through the G7

Felix Salmon
May 16, 2011 21:04 UTC


Thanks to Mohamed El-Erian for pointing this out in his latest Secular Outlook: the market risk spread on advanced economies now exceeds that on emerging economies.

Here’s Pimco’s explanation for what we’re seeing in this chart:

The difference in spreads shows the 5 year Markit CDX.EM.15 index minus the 5 year Markit iTraxx SovX G7 Index Spread. A positive number implies that Emerging Markets sovereign spreads are greater than Advanced Economy sovereign spreads. A negative number implies that Emerging Markets sovereign spreads are less than Advanced Economy sovereign spreads and therefore, the market implied credit risk for EM is lower when the spread is negative.

This is a very big deal, because the names in the EM.15 index are not exactly paragons of creditworthiness. Here’s the list: it starts with Argentina and Venezuela, and goes on from there, including countries like Panama, Russia, and Ukraine.

Meanwhile, the SovX G7 list is short and powerful: Germany, France, Japan, Italy, UK, and USA.

There are probably technical reasons why a group of AAA-rated sovereigns is trading wide of a group of much less creditworthy emerging markets in the CDS market. But the big message here is clear: the world is being turned upside-down. And most investors have yet to even start adjusting to these new realities.

Update: Turns out that the chart wasn’t measuring the G7 spread after all, but rather the Western Europe spread, which includes all the PIIGS.


Maybe bond investors realize the U.S. is really a banana republic like all the other listed countries.

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What is Kroll doing for Montenegro?

Felix Salmon
Aug 19, 2010 19:28 UTC

Landon Thomas’s report from Montenegro is full of fun datapoints, including the fact that the prime minister, Milo Djukanovic, officially gets paid only 1,256 euros per month. There’s also a delicious irony in the fact that he avoided prosecution by Italian authorities by declaring diplomatic immunity. And then there’s this:

As part of the plan to lure investors from around the globe, Mr. Djukanovic, who is also chairman of Montenegro’s investment promotion agency, said last week that any person willing to invest 500,000 euros or more could become a citizen of Montenegro…

Government officials say that the new applicants under the citizenship program will be thoroughly vetted by outsiders like Kroll, the risk consulting company.

Kroll, of course, is the company which was instrumental in allowing Allen Stanford’s $8 billion Ponzi scheme to go on for as long as it did. It’s also the kind of company which tries to hire freelance journalists to be its spies, because they are seen to be independent and above suspicion:

With one Google search, anyone could see that I was, in fact, a journalist. If I went to Lago Agrio as myself and pretended to write a story, no one would suspect that the starry-eyed young American poking around was actually shilling for Chevron.

I’m not entirely impartial here. Back when I was a freelance journalist, one editor would do things like ask me to write a story for his magazine, and then, after I filed it, tell me that I was an idiot to write it without a signed commission letter and that he wouldn’t run it or pay me. He went on to become a top Kroll executive in Brazil.

But putting all that to one side, I’m a bit confused about what exactly Montenegro is trying to achieve by making a big show of hiring Kroll to vet potential citizens. It’s not going to convince anybody that Montenegro isn’t plagued with corruption — quite the opposite. And Kroll doesn’t come cheap, even if you’re a country of only 670,000 people — so the country has to be getting some benefit from this contract. I wonder what it might be.

Emerging markets aren’t a bubble

Felix Salmon
Dec 4, 2009 15:31 UTC

Yesterday was the EMTA annual meeting, complete with its venerable and always interesting panel of buy-siders. My favorite is always Hari Hariharan of NWI managment: when asked what his favorite trade is, he never says something simple like “long Brazil”. Instead, it’s invariably a complex relative-value trade: this year he said that “a one year forward 2s-5s steepener in Korea could be an offsetting trade to receiving front-end Mexico”. You’re welcome.

Hari’s a smart and insightful guy, though, he’s not (just) a nerdy quant. When asked whether we were in an emerging-markets bubble, he pointed out that although property prices in Hong Kong are hitting insane levels in the region of $9,000 a square foot, those prices are being paid in cash, and banks aren’t lending against those values. And without leverage, of course, there’s a limit to how much harm a bubble can cause.

Similarly, I get the feeling that for all that Brazilian equities have been skyrocketing in dollar terms of late, that doesn’t mean that Brazilian companies have anything like the same access to the equity capital markets that they did before the crash: the primary markets haven’t recovered as well as the secondary markets, and people spending new money are still displaying signs of caution.

What’s more, in spread terms, emerging markets aren’t looking particularly bubbly, at least by 2007 standards when the EMBI+ index got as tight as 153bp over Treasuries. Right now, it’s 317bp over. In yield terms, however, things are much closer: 6.51% now (or yesterday, anyway, when the panel was going on and before the jobs report came out) compared to 6.37% at the low in in June 2007.

Mark Dow, of Pharo management, added that right now it’s easy to see bubbles everywhere, since we’re still so burned from the bursting of the last one. It’s a good point: while emerging-market assets may or may not be overpriced right now, it’s probably not particularly helpful to worry about bubbles. That said, everybody was a bit worried about the tens of billions of dollars flowing into Brazil from Japanese toushin funds: they’re not good for Brazil, and they’re unlikely to work out very well for Mrs Watanabe, either.

So although there’s bound to be some sort of correction in Brazil and other emerging markets sooner or later, that doesn’t mean they’re currently in a bubble. It just means that traders are making lots of money on the momentum trade right now, which isn’t the same thing at all.


Sorry I mean only after the fiat currency bubbles bust

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Dubai’s disabused creditors

Felix Salmon
Nov 27, 2009 17:03 UTC

The Economist has a good short overview of the situation in Dubai, which includes this interesting take:

Investors had half-expected Dubai World to seek forbearance from its bankers, asking them to extend their loans. But they felt sure the emirate would make good on publicly traded instruments, and in particular Nakheel’s sukuk, rather than suffer further damage to its financial reputation.

I remember the days when investors felt that in the world of emerging markets, publicly-traded bonds were implicitly senior to bank loans. But those days came to an end in the late 1990s with bond defaults in Pakistan, Ukraine, and Ecuador — and they’ve never returned. And it’s not even obvious at this point that restructuring loans is easier than restructuring bonds.

Certainly any entity like Dubai World carrying a large amount of bank debt would be very wary about needlessly infuriating its bankers by defaulting to them while remaining current on its payments to bondholders. If Dubai World’s bondholders really took solace in the fact that they held bonds rather than loans, they thoroughly deserve a large hit in the wallet. And as Willem Buiter says, it’s a good thing too:

Property developers tend to be highly geared and very procyclical in their revenue flows and access to the capital markets. During construction slumps they drop like flies. Because the property sector is risky (ask Donald Trump), its creditors tend to get better interest rates than the sovereign rate. Dubai is no exception to this rule. If you earn a risk premium during good times, you should not moan when the borrower defaults from time to time when the going gets tough…

Property companies don’t fall into the systemically important category. Their collapse is painful for their shareholders, creditors and, if the local labour markets are weak, their employees. They are not, however, systemically important. Their collapse will not threaten the delicate fabric of financial intermediation. They are fit to fail. Creditors beware.


The biggest problem with Roubini’s “W” is the assumption of the fourth leg.As Dr. Black noted, if I’m paying an interest rate that assumes a large chance of default, my willingness to default on that loan sooner than other financing should be assumed. (Brad DeLong keeps trying to argue against this; it’s roughly equivalent to Eugene Fama arguing that his EMH is not to blame for all of the structures that have been built on it [see P. Triana in the FT.)

The emerging-market bubble

Felix Salmon
Nov 25, 2009 21:21 UTC


This chart (via Paul) I think is too meek: of course the current emerging-markets boom is debt-financed. And boy does it look bubblicious, what with the Bovespa having doubled in the past 12 months and rapidly approaching its all-time high. I’m a believer in the long-term future of Brazil, and even count a Brazilian ETF among my few investments. But at this point any investment in emerging markets looks very much like a speculative momentum play: don’t invest anything you can’t afford to lose.


The Dot-com bubble was debt-financed? That’s a new one.

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The return of decoupling

Felix Salmon
Jun 4, 2009 21:18 UTC

John Authers thinks that since emerging-market bourses have outperformed developed-market indices over the course of this stock-market rally, investors are betting on decoupling:

The underlying trend is clear; rightly or wrongly the market believes that China and the other emerging markets will pull the world through.

I don’t think that’s clear at all. Given the degree to which emerging-market stocks underperformed on the way down, it’s only natural for them to outperform on the way up.

Emerging-market stocks are high-beta assets, and in times of general volatility, as we’ve seen over the past couple of years, they exhibit really high volatility. You need a strong stomach to invest in them, and you’re likely to get whipsawed quite a lot. But as a result, trying to extrapolate a big-picture global macroeconomic forecast from a relatively short-term movement in emerging-market stock indices is a fool’s game. I don’t think that EM stocks have ever been good forecasters of anything; there’s certainly no reason to believe they’re demonstrating something in particular right now.



Decoupling is bunk, but the relative ourperformance of emerging markets is real. I have analyzed this in my blog (please dont take this as a shameless plug). Here is the gist: This decade (starting Jan 2001), emerging markets have retunred 10+%, annualized, whereas S&P has returned -3%, annualized. Interestingly, emerging markets bottomed in November and S&P in March 2009. Lastly, a volatility adjusted portfolio of long EM versus short S&p would have made money in 2008!

The cost of sovereign default turns negative

Felix Salmon
May 26, 2009 14:49 UTC

Ecuador has closed out its bond exchange offer at the higher end of expectations, paying 35 cents on the dollar to investors who hold the 2012 and 2030 global bonds. That’s higher than the bonds have traded all year, and certainly higher than they have traded since Ecuador defaulted — which means that any vulture investors who bought the bonds in default will be able to lock in a decent profit for doing essentially no work at all.

What’s more, Ecuador has announced that anybody who put in an offer higher than 35 cents will be allowed to re-tender at the 35 cent level. This makes sense from Ecuador’s point of view, and gives people who tendered high the opportunity to re-think their strategy in the light of known events. It’s pretty clear that at this level a supermajority of the total bonds outstanding will end up being owned by Ecuador — which means that Ecuador will have the ability to strip a lot of creditor protections out of the instruments.

Ecuador has suffered no negative repercussions from its actions — quite the opposite. If the country needs any money in the next few years, it’ll be able to get it, from the Andean Development Bank or the Inter-American Development Bank or the World Bank or even the International Monetary Fund. None of them seem to particularly care that Ecuador defaulted on its global bonds, and emerging-market bondholders are so weak and fragmented these days that they hold very little sway any more within international financial institutions.

Indeed, given the short memory of emerging-market bondholders, I wouldn’t be surprised to see Ecuador regain its access to the international capital markets within a few years, thanks to the way in which it has managed to substantially reduce its (already pretty low) debt-to-GDP ratio. That could well be the thinking behind the decision to remain current on the 2015 global bonds, which were issued when current president Rafael Correa was finance minister. Look, he’s saying: we pay back the money that we borrow. We just don’t pay back debt which was originally borrowed decades ago and which was restructured twice in a manner designed to be as friendly as possible to private-sector creditors.

Looking at this from a systemic perspective, it’s pretty clear that in this instance the cost of default, to Ecuador, was negative. That’s dangerous: it radically increases the probability of tactical defaults from all manner of other countries, including Argentina, Venezuela, and various African states. And once a wave of sovereign defaults starts, it’s very difficult to stop, since the cost of default drops with each new event. Right now the risk of such a wave is surely near a multi-decade high.


One of the interesting features of this default is the revival of the idea of different treatments accorded to different types of debt. There is a long history of such practice. The main purpose has always been to gain the short-term cost benefits of default without incurring the lont-term penalty of reduced access to the credit markets.

In this case, the regime treats its own debts as legitimate while treating those of its predecessors as illegitimate (or at least less legitimate). Eighteenth- century France used a different technique: treating previously defaulted debts as immune to further write-downs, while more recent debts were viewed as fair targets for default because their interest rates were, not surprisingly, considerably higher and could therefore be deemed usurious.

After the Napoleonic War, France finally became a reliable borrower, and one of the main demonstrations of this was honoring the Napoleonic debts in spite of the temptation to repudiate them. It was argued at the time that this was not merely a matter of good faith, but rather an unavoidable price for access to the credit markets on favorable terms as enjoyed by Great Britain.

To my mind, this remains a valid argument. Historically, default almost always had a negative short-term cost – it certainly did so on for France before 1815. The regime always had access to new loans after each bankruptcy; but its access to credit was limited by its previous track record. Attempting to justify its actions by differentiating between types of debt did not fool creditors. They may have continued to lend, but always at rates that factored in the risk of default, and in amounts considerably lower than they were willing to lend to Great Britain.

Just because Ecuador currently experiences a short-term gain will not turn it into a good credit risk. Only paying debts regardless of short-term incentives to default will remove it from the vicious cycle of borrowing and default which has mired Ecuadorian (and Latin American) history since liberation from Spain.

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Where are Ecuador’s bondholders?

Felix Salmon
May 19, 2009 19:35 UTC

According to Ecuador’s finance minister — and there’s no reason not to believe her — there’s been “excellent” take-up of her offer to buy back Ecuador’s 2012 and 2030 bonds at somewhere in the neighborhood of 30 cents on the dollar. As Reuters’s Maria Eugenia Tello notes,

Most holders of defaulted debt have so far failed to create a united front against Ecuador to seek repayment via courts.

This is in contrast to what happened the last time the Ecuador defaulted, in September 1998. Back then, Ecuador made the announcement in the middle of the annual meetings of the IMF in Washington, and substantially all of Ecuador’s bondholders were in the same place at the same time. It didn’t take long for them to organize meetings and reject Ecuador’s offer to pay some bonds in full while in other cases using the bonds’ own built-in collateral to keep current.

Why do bondholders seem to have lost cohesion over the past decade? At the time, I thought that the experience of Ecuador’s 1998 default was going to be the event which catalyzed bondholders to come together as a much more unified bloc — and indeed the Emerging Market Creditors Association was formed as a direct result of the way that the Ecuador default was handled.

But EMCA fell apart, nothing really took its place, and a major global financial and economic crisis kinda took the wind out of bondholders’ sails. At this point, most of them have neither the energy nor the time horizon nor the levels of capital needed to rally and fight — Ecuador’s timing, you could say, is perfect in that regard.

What’s more, any holdout strategy is fraught with risk:

Many market watchers on Wall Street say Ecuador has a key advantage because Correa had already bought back most of the debt when the country started to threaten a default and dragged down market prices in late 2008. Ecuador has not confirmed or denied past buybacks.

The point here is that if and when Ecuador controls a supermajority of the bonds — which it certainly will by the time the exchange is over, if it doesn’t already — it can start modifying a lot of the covenants in them, making a court fight that much more difficult. Most hold-out or “vulture” creditors tend to dislike litigating bonds in any event, preferring loans instead, which tend to have stronger covenants.

So if there are any hold-outs, their best hope will be that they’re in a tiny minority, and Ecuador just does what it did last time, and pays them off in full because it’s easier and cheaper than fighting them in the courts. But the hold-outs would probably need to amount to less than 4% of the amount issued before Ecuador went down that route.

Will there be 96% takeup of this offer, including bonds Ecuador already owns? It’s possible, but I suspect that there will be enough too-high bids, in the 40-cent-and-over range, to stop that from happening. In which case Ecuador’s holdouts will find themselves in much the same position as Argentina’s. Which is to say, an unhappy position indeed.


Felix your note are very good
wright more please

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