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International Economics, 10/20/22

Updated: Apr 5, 2023

Good morning and welcome back to International Economics, a roundup and review of the key stories moving global markets. We would love to hear any feedback, news ideas, or thoughts for improvement as we start out.

This Week: Looking for the next financial crisis. It seems that market observers have gone from debating a recession to hunting for a crisis in relatively short order. As financial markets appear more sensitive and confusingly distorted, the tail risks for the global economy and its countries seem to be growing by the day. Part of this is because we haven't had a real (sorry forced-COVID-mini-recession) period of contraction for around a decade now. The degree of complexity this time is also orders of magnitude higher than even 2008, which had a relatively linear, albeit quite technical, cause.

This time, concurrent crisis makes isolating effects difficult, to say the least. Will the underlying cause of the next crisis be more policy missteps of the sort the UK has put on full display or quantitative tightening creating slack in bond demand and forcing central banks into asymmetric policy constraints? A loose causal mechanism is looking possible from the current dislocations and illiquidity in government bond markets, where sovereign bonds turn out not to be so risk-free as current financial regulations posit and banks move to cut exposures leading to a front-loaded "doom loop" of higher borrowing costs and market-implied risks in some governments' paper - all potentially magnified by counter-party risk in opaque OTC derivatives or run risk in money market mutual funds. Perhaps the "next crisis" framing is inherently inappropriate though, leaving us with a boring but drawn-out recession from a coordination decline in growth not counteracted by Chinese spending as the case after the GFC.

Have a more sanguine view of the world economy or a different take on the drivers of risks? Let me know at

Global Macro

Asian economies falter amid weak currencies, high debt, and limited policy options but a 1997 repeat remains unlikely.

The combination of widespread currency weakness, rapid US rate rises, and capital outflows is beginning to remind Asian investors of the 1997 currency crisis. So far, US rates have already crushed Sri Lanka and contributed to growing default risks for Laos, Pakistan, and Bangladesh. But even across more stable economies of India, Vietnam, and Japan, currencies, bonds, and stock markets have seen concurrent falls as global tightening triggers outflows in what has been investors' favorite growth region. Despite concerned corporations and irked investors, IMF projections show Asian economies with much stronger fundamentals compared to 1997, making a crisis unlikely while pain remains inevitable and significant divergence likely.

Meanwhile, currency markets are in chaos, partly as a result of differing inflation-fighting strategies and varying capacity to contend with a dollar at its highest level since 1995 in trade-weighted terms, according to the Bank for International Settlements. The same rate rises driving the dollar's appreciation are also creating the conditions for capital outflows, with countries across the region seeing the largest exit of hot money since 2008. While challenging in itself, these factors risk exacerbating the high debt levels as QE fueled large spikes in property prices and a leveraging up of Asia Inc, which both carry stability risks if financial conditions become even less accommodative.

  • Additional reading: Thai banks' interest rate hikes spark economic concerns. (Nikkei)

In response, policymakers are scrambling to stabilize their currencies and avoid anything resembling 1997. However, across the region, central bankers are pursuing divergent paths amid constrained policy options and overlapping crises. The central banks in the Philippines and India have become among the most hawkish, with 225bp and 190bp raises, respectively, this year as both currencies hit all-time lows against the dollar. Meanwhile, Indonesia, Malaysia, and China are on a dovish spectrum that ranges from delaying tightening cycles to cutting rates repeatedly in the PBOC's case. However, in many of these countries, policy rates are losing steam as further blanket increases risk, disproportionate economic damage, and debt risks. As such, Japan and India have undertaken $20bn and $75bn FX interventions, respectively. Both programs have slowed but not stopped depreciations that show little sign of finding new resistance levels.

The Japanese yen fell to a historic low of 145 to the dollar at the end of September, amid economic chaos across Asia. (Photo by Kosuke Imamura)

With the terminal fed funds rate rising on resilient labor market and embedded inflation, further dollar gains appear inevitable. Given this reality - and war-related inflation hitting Asia harder - these divergences will likely be further magnified over the next three quarters. This divergence between countries' policy approaches - mirrored throughout the world - offers an interesting continuation of the experiment started with large-scale EM-QE. As responses to crises begin to beget crises themselves, the opportunity for natural macro experiments can emerge from a period of heterodoxy in economic policy.

Developed Economies:

Chinese financial crisis and slowing growth carry global risks in spite of ‘Fortress China’ insulation.

The reality of China's slowing economy has thoroughly overshadowed the political exercise of extending Xi's rule - at least in Western Media. Beijing might be accused of falling for Streisand Effect by taking the abnormal action of blocking GDP figures from being released and pressuring banks to avoid certain topics before the Party Congress. With external GDP figures suggesting 3% growth on the back of covid lockdowns, a slowly moving housing-financial crisis, and declining volumes of global trade, it appears China's time to rejig its economy as consumer lead is less than it appeared. While economists forecast in the high fours, the potential for structurally lower growth is leading to some projections that have grown at an average of 3% over the next decades. The nature of demographic challenges behind slowing growth has concerned defense and political economy observers that see growing geopolitical disruption while China is strong enough, as the argument goes.

While the speculation of an invasion attempt is beyond the focus of this newsletter - although it would certainly make that 4% growth impossible for years - Beijing poses a risk in recession even during peacetime. The argument that Chinese growth slowing carries grave global consequences appears to get the causality wrong at first glance. First, faltering export-led growth would suggest that the global economy is already slowing, with Chinese growth merely reflecting a normal cycle for a larger exporter. Additionally, 'Fortress China' - Xi's strategy to sanctions-proof China's economy - appears to have isolated many of the traditional transmission mechanisms for financial crises. Its banks are not well integrated keeping the risks accumulated output-demand (ie debt rather than sustainable demand) growth domestically isolated.

However, Chinese consumers have played a large role in exporting capital abroad, primarily to the US. Despite being roughly eight times smaller at the time, overseas Chinese investments were large enough to play a substantial role in the froth and eventually collapse in US housing. Geopolitics plus slowing growth has already started to cut off private markets, from movie financiers to venture capitalists, from a key source of funding. Despite this the US is a bit similar to a fortress itself, and so can safely avoid the bulk of risks from a structural Chinese slowdown. The rest of the world cannot say the same as Europe faces continued supply chain integration, EMs are reliant on Chinese lending, and exposure to the large consumer market carry risks of a more painful recession. Finally, the slowing volume of credit generation leave China unable to repeat the large-scale lending and commodity purchases that bolstered global recovery after 2008.

Beggar-thy-neighbor’s grid: German energy package risks internal market and forces rethink of debt rules.

After Germany launched a €200bn (5.6% of GDP) debt-fueled stimulus package - the uproar and calls for action looked like the EU might be on the edge of another faithful leap towards integrations. In response, countries like Spain and Belgium criticized the package's size, the possibility of higher energy prices, and competitive distortions to the single market. The risk of substantial internal distortions raises the incentive for peripheral borrowers to further test their fate on bond markets for the hundreds of billions needed to protect businesses, boost defense spending, and afford energy inputs.

German Finance Minister Christian Lindner, Economy Minister Robert Habeck and Chancellor Olaf Scholz in Berlin on October 4, 2022. Michele Tantussi/AFP

These additional demands to borrow have emphasized the European Commission's consideration of wide-ranging reforms to fiscal rules. These reforms would primarily loosen the much-derided Stability and Growth Pact (SGP) that theoretically limits deficits to below 2%, giving countries more time to reduce debt stocks. The reforms would also introduce national fiscal plans without the mandatory debt reduction ratios when debt is higher than now quaint sounding 60% of GDP.

  • Further Reading: Italian bond yields rise as German support for joint EU debt seen as unlikely. (Reuters), Spain unveils 3 billion-euro energy aid plan for households. (AP)

While overdue, such changes would not be immediately impactful as the SGP - routinely ignored anyway - has been frozen since 2020 and is only set to return into force in 2024. Within the Spanish, Belgium and Italian warning of distortions lay the true intent: mustering support for another round of joint borrowing to take advantage of the bloc's lower average borrowing costs to fund equivalent packages. The notion was quickly put to rest though, as French and German finance ministers rejected the prospect, exercising their de facto veto on what would amount to as much as €550bn on top of multiple existing packages.

Emerging Economies:

Chile charts a path back to economic orthodoxy, breaking from other left-led LATAM leaders.

Chile's leftwing government is engineering one of the world's most dramatic reductions in public spending, pleasing investors who had been worried by President Gabriel Boric's large-scale spending promises. In an interview with the FT's Michael Stott, finance minister Mario Marcel laid out his plans for financial discipline as market sentiment has become increasingly sensitive to policy uncertainty and stable public finances take center stage.

  • Further Reading: IMF Urges Governments Restrain Spending to Fight Inflation. (WSJ)

Boric's eight-month-old government arrived with promises for additional spending on pensions, health, and education. Instead, market uncertainty following the constitutional reform efforts has forced a 24% reduction in public spending and shelving of more ambitious reforms that "could not be continued because of weakness in the economy and a lack of state resources," Marcel told the FT.

Finance minister Mario Marcel © Cristobal Olivares/Bloomberg

The current discipline reflects a broader shift towards the traditional center-left fiscal prudence. The spending cuts also highlight how Chile's traditionally technocratic leaders aim to steer the country out of the troubled waters other left-wing governments face. As Brazil, Colombia, and Argentina keep spending elevated to deal with slowing growth, they risk exacerbating inflation and making their economies vulnerable to the impact of tightening global financial conditions.

Hungarian central bank shocks overnight interest rate to fight back forint short sellers.

The combination of a concluding tightening cycle, rapid rises in FX transaction volume by energy suppliers, rising budget deficit, and large short positions led to a rapid deterioration in the Hungarian florint this week. The currency hit record lows, falling 14% and 36% against the euro and dollar, respectively. The rapid fluctuations had led the florint to underperform all CEE currencies, like the Polish zloty and the Czech crown, despite significantly higher interest rates.

The National Bank of Hungary increased the overnight loan facility from 15.5% to 25% © Laszlo Balogh/Reuters

In response, the National Bank of Hungary - which had declared an end to hikes a few weeks prior - was forced into drastic action. During an emerging Monetary Policy Council meeting, the bank launched a series of measures, including a 9.5% hike in its main lending facility for banks, one day FX swap to reduce florint trade prices, and a 500bp rate premium on overnight deposits to make the currency more attractive and ward off short sellers. In response to what one ING senior economist called the use of "tactical nukes," the florint recovered some losses, ending 3 percent higher. Meanwhile, yields on the benchmark five-year government bond shot up 120bp.

While the measures are expected to calm the market, for now, the central bank is in a challenging position that one FT Alphaville contributor calls Zugzwang central banking - referring to the situation in chess where any possible move makes one's position worse. The current 17% interest rates after an aggressive tightening cycle make further blanket rate increases economically damaging. Meanwhile, multiple FX interventions are costing the bank up to €1.5bn, or roughly 5% of gross reserves, and the balance of payment problems from hard currency energy imports show no sign of slowing. This leaves the bank betting on demand destruction to lower imports and close the deficit, a situation which shows how difficult of a time financial firefighters are having with overlapping crises and rising market fragility.

New gas projects propel Senegal to outpace Sub-Saharan Growth.

Senegal's economy is set to see the fastest growth according to recent forecasts by the IMF that project the West African economy seeing 8% growth. The gas exporter has seen a rapid uptake in FDI as European countries look to Dakar for gas exports to help replace Russian supply. The new Greater Tortue Ahmeyim LNG project in Senegal and Mauritania is set to start shipping its first gas in 2023, reports Moses Mozart Dzawu in a dispatch for Bloomberg. Senegal beats other emerging producers like Uganda, DRC, and Cote d'Ivoire, which are also set for rapid growth on the backs of strong energy exports.

Final Note: Remember the 2018 Rusal mistake when considering sanctions on Russian aluminum.

The Biden administration is reportedly weighing import bans, punitive tariffs, and/or sanctions on Russian aluminum in response to renewed attacks on Ukrainian civilian infrastructure, Reuters reports. The move would be a serious escalation of sanctions and mark a reversal for the White House, which previously claimed that similar sanctions would be too disruptive to markets as Russia's Rusal is the world's largest aluminum producer outside of China.

In fact, their share of the global aluminum market is similar to where it sat after the 2014 invasion of Crimea and subsequent sanctions. With the 2018 round of sanctions under CAATSA, Rusal was hit with secondary sanctions given its oligarch owner's ties to Putin. While Treasury had initially assessed collateral damage to be akin to the sanction-driven oil market disruptions from Iran before the nuclear deal as Rusal and Iran hold comparable shares of the aluminum and oil markets, respectively. In reality, aluminum is not highly fungible, and a different market structure made Rusal relatively more important than Iran. Additionally, excess capacity theoretically available was and continues to remain in China, where prices are higher and the export market is less attractive.

A worker forms aluminium ingots at the foundry shop of the Rusal Krasnoyarsk smelter in Krasnoyarsk, Russia REUTERS/Ilya Naymushin/File Photo

The effect of more stringent certification and purchase restrictions in the sanctions was immediate; Prices for alumina and aluminum shot up over 100% and 25% respectively as Rusal customers scrambled to find alternative suppliers. Within weeks, Germany, France, Ireland, Jamaica, and industry groups were all lobbying for reprieve as the move effectively shuttered entire industrial supply chains as firms struggled to reach compliance in unrealistic time frames. While the folks at OFAC have likely learned these costly lessons, the White House's foreign policy eyes look bigger than its stomach, given the skewed risks of disrupting another important facet of the global economy

In Other News:

Transatlantic jobs market ‘coming off the boil’ as vacancy numbers drop. (FT)

The Stagflationary Debt Crisis Is Here. (Project Syndicate)

Crypto Hackers Set for Record Year After Looting Over $3 Billion. (Bloomberg)

Against war and other shocks, pandemic fades from world economic agenda. (Reuters)

Most people don’t know what GDP growth is. (FT)

Inflation, Rate Rises Dim Corporate-Bond Outlook. (WSJ)

‘Ridiculously stupid’ economic policies have the U.S. hurtling toward a ‘perfect storm’ of economic pain, Ray Dalio says. (Fortune)

Bullard Becomes Wall Street’s Go-To Guy for Hint of a Fed Pivot. (Bloomberg)

Will Jerome Powell’s Inflation Crusade Get as Ugly as Paul Volcker’s? (Bloomberg)

The Reporter Who Knows What Jerome Powell Is Thinking. (NYMag)

Fumio Kishida backs Bank of Japan’s ultra-loose policy despite yen plunge. (FT)

Japan's Bond Market Awakes From Weeklong Slumber. (WSJ)

China chip stocks lose $8.6bn in wipeout due to US export controls. (FT)

Xi seen giving China's economic reins to trusted ally in third term. (Nikkei)

Russia Loses 60% of Its Seaborne Crude Market in Europe. (Bloomberg)

Russian Consumers Are Feeling Less Confident After Turbulent September. (Morning Consult)

War-Torn Ukraine Needs at Least $3 Billion a Month in 2023, IMF Says. (Bloomberg)

Up to 15 years of gains wiped from some gilt ETFs. (FT)

The UK’s Crisis Is Threatening the Global Inflation Fight. (Bloomberg)

The pound vs the dollar: a history. (FT)

In Greece, Energy and Economics are Bigger Headaches than Eavesdropping. (BalkanInsight)

Iranian Oil Workers Strike, Raisi Heckled As Protests Enter Fourth Week. (Radio Free Europe)

Ethiopia May Allow Overseas Lenders to Own 30% of Local Banks. (Bloomberg)

IMF chief Georgieva aims to complete Zambia, Chad debt restructuring by year-end. (Reuters)

Financial Action Task Force to Put Congo on Its Gray List. (Bloomberg)

Zambia Finance Chief to Africa: Don’t Wait to Rework Debts. (Bloomberg)

Chilean lawmakers approve Trans-Pacific Partnership. (Reuters)

What Is the Value of an Argentine Peso? It Depends on What You're Buying. (Bloomberg)

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