Concerns over a 1997-redux are brewing. The parallels are staggering. Asia is facing growth pressure. Emerging markets are going belly up. Currencies are rapidly deteriorating as the Federal Reserve considers monetary tightening. Japan is on the verge of fiscal tightening. These are all the same ingredients that led to the 1997 Asian crisis. Are we looking over the edge, or is there hope to avoid another financial crisis?
First, a look at emerging market currencies: they’ve been hammered in 2013 far too similar to the pain seen in 2008. The Indian Rupee hit its lowest exchange rate ever against the U.S. Dollar in the 3Q’13; the Indonesian Rupiah is halfway back to its lows; the Brazilian Real is a few percent away from its lows; and the Turkish Lira, burdened further by recent political discord, it at its lowest levels ever.
So much for the “carry trade,” of which all of these currencies are considered. Why? They have higher yields. They are expressed in the form of the sovereign bonds. It is important to distinguish the difference between “higher yields” and “higher yields.” Stick with us – there’s a clear distinction.
Higher yields are used to refer to two, opposite situations: one in which a country, with more obvious inherent risk (politically, economically, socially), offers a “higher yield” but is considered a worthwhile investment given the optimistic projected path of the economy – economic liberalization, a stable political environment, reduced risk for violence. The aforementioned emerging market economies share these characteristics: optimism for a brighter future.
The other type of “higher yield” is when there is panic. There is no optimism for a higher future; higher yields result from investors selling the bonds (bond prices and yields are inversely correlated). This can result from a number of influences – war, higher inflation, political instability – as well as the threat of reduced liquidity. The higher yields we’ve seen in these emerging market economies over the course of 2013 represents the wrong type of higher yield, predicated on exogenous circumstances – the Federal Reserve winding down its stimulus program .
Does this mean that another 1997 Asian crisis is upon us? Possibly, maybe among the BRICS. As the chart to the left shows, international claims to GDP – foreign banks’ lending – is rising at a pace that puts it on par to where the Euro-Zone was three years ago. It also puts the BRICS on par with the Asian financial crisis in 1996/1997. These are concerns that must be monitored considerably in the weeks ahead. Excess volatility will greatly enhance the need to reduce portfolio risk through hedging.