Last week, Brazil became the latest country to act in order to shore up its currency as investors piled out of emerging markets. The Brazilian currency’s value went down 20% against the dollar since the start of the year, while the rupee is down 15% and the Turkish lira down 10%. The situation reminds many investors of the catastrophic Asian financial crisis of 1997-98. During this crisis, Thailand was the first of the fast-growing “Asian tiger” economies forced to turn to the International Monetary Fund (IMF), as foreign investors lost heart and left and the nation’s thus currency plunged, sparking a chain reaction.
Back in 1997, it was Alan Greenspan’s decision to push up interest rates that sparked investors to pull out their equity from riskier markets to take advantage of better returns back home. Today, it’s the announced intention of Ben Bernanke, the chairman of the Federal Reserve, to begin “tapering” its unprecedented $85bn a month programme of quantitative easing (QE), perhaps as soon as next month. The crisis, if there is one, may be caused by the change of heart by the Federal Reserve, thousands of miles away in Washington.
Under the QE project, the Federal Reserve buys up assets, mainly US government bonds or US treasury notes in a bid to push up their prices. This funded purchasing helps to reduce interest rates across the economy and create the conditions for recovery. The notable side-effect of the QE policy is that banks and other investors use the cheap cash to go on a global shopping spree, looking for tempting investment prospects from all over the world. When the money is starts to roll in, this inflates share prices and drives down the cost of government borrowing. It’s easy for authorities in third world countries to believe their own hype – political stability, the rising middle class, a large and growing workforce, huge untapped potential. But when the tide turns, they can suddenly become acutely vulnerable.
However, there are quite a few reasons that can be listed that can be a cause for us to stay optimistic. Many emerging economies have piled up vast stockpiles of foreign currency reserves in the past 15 years in a deliberate bid to avoid being forced into the hands of the dreaded IMF. Few are actually reliant on the type of loans that were a problem back then, and the Federal Reserve is acutely aware of the potential risk of sparking a new financial crisis.