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Investing in emerging markets: the risks from a falling dollar

The World Bank and IMF warn that US measures to boost its economy are already causing problems in the emerging markets.  But should you be worried? 

 

The World Bank and IMF warn that US measures to boost its economy are already causing problems in the emerging markets.  But should you be worried?

With economic growth looking lacklustre and interest rates set to stay on hold for years in much of the developed world cash has been flowing towards the emerging markets, sparking fear a bubble may be forming.

More than $3.25 trillion of cash has been injected into the global economy by central banks hoping to limit the impact of the downturn and stimulate growth. Combine this with all of the government spending and the amount of cash sloshing around looking for a home is substantially higher.

The dollar has been under pressure over recent weeks as it looks increasingly certain that the US rate-setters are going to push ahead with more stimulus. But can the emerging countries withstand the impact of the inflows of cash coming their way or should you be worried?  

Inflows could cause problems

The World Bank, the International Monetary Fund and even the Bank of England's governor Mervyn King, have all issued warnings that the cash could cause problems for the emerging markets.

Vikram Nehru, chief economist for the East Asia and Pacific region at the World Bank, said: ‘Should inflows remain strong, especially against a background of weak global growth, the authorities will be faced with the challenge of balancing the need for large capital inflows - especially foreign direct investment - with ensuring competitiveness, financial sector stability, and low inflation.’

Referring to Latin America and the Caribbean, the IMF issued a report saying these countries need to deal head on with the challenges of allowing credit to expand safely, without creating excessive risks in the context of low global interest rates and capital flows to emerging economies.

New inflow controls may cause new problems

And their concerns are not falling on deaf ears as a number of emerging governments have introduced measures to try and stem the flow of money.

Brazil has trebled the tax for overseas investors buying its bonds to 6% in less than a month, while Thailand introduced a tax on interest and capital gains earned by foreigners on Thai bonds. South Korea has said it is considering a similar move.

But these protectionist moves also have the authorities worried. 

 Speaking in the Midlands on Tuesday, King said: 'The need to act in the collective interest has yet to be recognised, and, unless it is, it will be only a matter of time before one or more countries resort to trade protectionism as the only domestic instrument to support a necessary rebalancing. That could, as it did in the 1930s, lead to a disastrous collapse in activity around the world.'

And some say these countries just have to accept that investors are behaving perfectly logically.

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5 comments so far. Why not have your say?

jimmyt

Oct 24, 2010 at 11:31

Anybody who decries emerging economies for imposing capital controls to stem flows of hot money has an excessive case of short term memory myopia... The 1998 Financial Crisis in the East Asian economies, which spread rapidly in all countries that didnt have capital controls in place, is proof of the volatility of sentiment and herd mentality when problems kick in.

And whilst we are at it, some controls at home to prevent ridiculous short term trades and gambles wouldnt go amiss as a contributory factor in stabilising our own economy, and maybe diversifying away from our bloated financial sector. Investing in productive long term growth measures is the only viable way out of our slow and steady decline.

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William Bishop

Oct 24, 2010 at 13:02

So far the risk for emerging economies and markets seems to be more in the direction of specific bubble situations, e.g. Chinese residential property, than generalised inflation or lack of competitiveness - to the extent that all emerging economies are involved, it might be questioned whether competitiveness is not a red herring anyway.

The last bubble in emerging stock markets dates back to 1993/94, on which basis we may be about due another one, but I don't think that we are there yet.

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William Phillips

Oct 24, 2010 at 15:56

Here we go again with free trade fetishists, fiat money maniacs and globalist citizens of the world moaning about 'protectionism' and 'isolationism' and how much it should be dreaded by everyone (like deflation, which dares to replace the moral hazard of indebtedness with rewards for thrift).

Britain had protection ('safeguarding of industries') in the 1930s and we came through the convulsions of those times in better shape than most, able to win a world war. Afterwards ordinary folk prospered as never before in a semi-socialised economy. The Thatcher-Reagan interlude may have been a necessary tonic, but it was aberrant and brief.

Free trade has always been largely an Anglo-American fixation, like frenzied secondary trading in shares. Japan was fiercely protectionist during its postwar boom. French Gaullist dirigisme and Spanish technocracy regenerated those nations in the 1950s and 1960s. At the same time Japan's MITI pushed its banks and industrial conglomerates around and kept aliens out. Latterly China has flourished without surrendering huge sectors of its economy to gaijin. Germany, the only nation keeping the EU afloat, has had plenty of drawbridge-closing moments since WW2 too, even during its 'economic miracle' period under Adenauer. For example, its guestworker programme allowed it to regulate cheap labour flows so its own people weren't priced out of jobs as ours are.

The truth is that neither autarky nor international 'freedom' to move money, export work and buy into other people's business are a complete, permanent answer to the world's cyclical spasms. Often central governance does better. Generally it's the mature, labouring economies which advocate free trade-- trying to set the regimen under which they boomed in stone, until the price for their own kind becomes too high for the local plutocracy to get away with it. America may have reached that tipping point, now so much of its manufacturing base has been outsourced to foreign competitors.

Conversely, if the barriers become too high and remain too long, the public gets fed up with being controlled, rationed and deprived of goodies and demands liberalisation. But even a regime as cruel and absurd as Soviet communism achieved growth rates which scared the USA in the Fifties, and before that-- after only 20 years-- could win the greatest war in history.

Right now, there is a mood of austerity which affects both western electorates, hung over from their long credit debauch, and Asiatic peoples sensing their destiny as hegemons if only they maintain internal disciplines of thrift and gradual enrichment.

The elites of the West are still preaching the old remedies: 'stimulate' demand by printing money, spend more and save less, let industrialists eviscerate national manufacturing bases by exporting investment capital, welcome foreigners buying up our strategic industries.

None of this cuts much ice in China and India , which can run closed economies with less discomfort than former imperial and neo-imperial powers dependent on exchanges of goods, services and workers. Moreover, technology is making self-sufficiency more feasible, as well as more desirable in the dawning era of Peak Oil and Peak Food. The old Ricardoesque model of a single world economy swapping competitive advantage, under regulation by markets and price signals, is becoming as out of date as its political counterpart: end-of-history liberal democracy.

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dereklkl;l hdjkaK;LL'a

Oct 24, 2010 at 18:26

Wlliam Phillips - I have never heard so much errant nonesense as you talk!!"!!!

"Britain had protection ('safeguarding of industries') in the 1930s and we came through the convulsions of those times in better shape than most, able to win a world war. Afterwards ordinary folk prospered as never before in a semi-socialised economy."

Yes right! 15 years of post war misery despite the USA investing billions under the Marshall plan.

"But even a regime as cruel and absurd as Soviet communism achieved growth rates which scared the USA in the Fifties, and before that-- after only 20 years"

????? Soviet Union, what Soviet Union, Oh, the one under soviet communism which produced useless 3 ton railway wheels to target , along with millions of pairs of shoes in sizes no one wanted, but abosuletly to target.. Do you think their growth rates might have been the teenist bit inaccurate!!!

Adam Smith was abosuletly right and continues to be the only game in town.

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Anthony Williams

Jan 06, 2011 at 16:55

how many chinese dynasties have there been. when i visited china 20 years ago there was a work ethic, yes, difficult with mtse tung but he needed everybody to produce rice to feed 1 billion people, acheived. there was no room for health and safety, and freebees for not working, or imports of people around the world that are paid for sitting idly by.europe two thousand years old.how old is the chinese history, 4000, 5000. i rest my case

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