Wall Street and Emerging Markets

Stephen DeAngelis

September 18, 2008

Amidst all the bad news continuing to emanate from Wall Street and the accusations of corruption, greed and incompetence aimed at corporate executives who permitted it to occur, Americans haven’t take much thought about the effect all of it is having on emerging markets around the world. As troubles in the American economy ripple around the globe, fears of a recession or depression are starting to grow and some countries appear on the cusp of economic panic [“Russia Again Halts Stock Trading,” by Philip P. Pan and Anthony Faiola, Washington Post, 18 September 2008].

“Russia suspended stock trading for a second straight day and took other emergency measures in an attempt to halt a severe crash Wednesday [17 September] as market turmoil spread to Latin America and raised fears the U.S. crisis will test the strength of the emerging economies that supply oil and other commodities to the world. Already battered by falling oil prices and capital flight in the wake of last month’s war with Georgia, Russian stocks fell sharply for the third consecutive day despite a decision by the Kremlin to lend $45 billion to the nation’s three largest banks. Trading was suspended at midday; more than five hours later, the government sought again to calm the markets by slashing reserve requirements for banks, freeing up as much as $12 billion.”

I doubt Russia or any other oil rich nation is going to get much sympathy from the man in Iowa about “falling oil prices.” It’s hard to understand how an economy could be “battered” when oil is still selling around $100 per barrel, far above where it was three years ago when these same emerging economies were doing nicely selling $40 per barrel oil. The problem, of course, is perception more than reality. The global economy is not (at least it should not be) as unstable as the U.S. economy which is now paying the price for year’s of living on credit and little fiscal constraint. Most emerging economies have much higher savings rates than the U.S. and if those savings are invested well, emerging economies should still grow at a reasonable rate even as the U.S. economy stumbles to a recovery. Russia seems to have been hit harder than other emerging economies.

“Analysts blamed the immediate declines [of the Russia ruble] on a liquidity crisis — a shortage of money — caused by tightening access to international credit, and a chain reaction of selling by investors who took out loans collateralized by stocks that have suddenly lost much of their value. But the sell-off also reflected investor panic over the health of an economy largely dependent on oil production as petroleum prices have plummeted in recent weeks.”

Russian citizens also remember the difficult times caused by the 1997 economic crisis labeled the “Asian Flu” that started in Southeast Asia and jumped to most emerging market economies. Although most of the countries affected survived the “flu” and again began to prosper, the years following the crisis were difficult. With oil prices still relatively high, the “plummeting” price hardly makes oil a bargain or threatens the treasuries of oil producing countries. Pan and Faiola report that aside from Russia the people seem to understand that reality.

“The market turmoil did not appear to spread to all other major oil producers. Stock markets in Kuwait, Saudi Arabia and the United Arab Emirates, for instance, saw gains Wednesday, while Nigeria and Venezuela were modestly down. But the Venezuelan currency tumbled for a sixth straight day, in part on concerns about oil prices. Brazil, a major exporter of metals and food that also produces oil, suffered a massive sell-off, with the stock market falling 6.7 percent to its lowest level since April 2007 and the local currency dropping to a one-year low against the dollar. Stock markets in Mexico and Argentina also fell sharply, with companies in the mining, oil and financial sectors hit particularly hard. In effect, the U.S. financial crisis is presenting these emerging-market nations with their first major test since their economies got back on track and began experiencing the rapid growth of the past several years. ‘I think this has quite little to do with dropping oil prices or any reevaluation of the long-term prospects’ in commodity-producing emerging markets, said John B. Chambers, managing director of Standard & Poor’s. ‘I think this has a lot more to do with financial agents elsewhere needing to raise money any way they can, so they’re selling in places where they can.’ But the possibility of a slowdown in these emerging markets continued to affect the yields many of them must pay on bonds, making it more expensive for governments to cover their debt payments. The currencies of several countries were also slammed Wednesday, slipping against the dollar as investors anticipated reduced inflows of foreign investment.”

The current financial turmoil should go a long ways toward convincing countries that rely mainly on commodity exports that they must diversify their economies in order to smooth out high and lows created by conditions elsewhere in the world. There are too many new middle class consumers in emerging market countries who have tasted the good life and want it to continue for me to believe that the current situation is much more than a speed bump for them. Pan and Faiola provide some evidence that this is true.

“Emerging markets overall are far better prepared to cope with turbulence than they were in the 1990s, when a series of financial crises swept Russia, Latin America and Asia. The commodities boom has given them more cash on hand, and many have cut the overspending that had made them heavily dependent on foreign investment. The continuing turbulence in Russia, for example, appears fundamentally different from the crisis that crippled the nation in 1998, when the government defaulted on debt payments and the ruble collapsed, wiping out the life savings of many ordinary Russians. Today, the government is awash in oil money, boasting no debt and nearly $600 billion in foreign currency reserves, more than all other countries besides China and Japan. After Tuesday’s record sell-off, the Kremlin demonstrated its willingness to use that cash, pumping money into the country’s three largest banks, Sberbank, VTB and Gazprombank, in the hope that they would then lend money to smaller banks, many of which are said to be struggling to stay in business. One of them, the boutique investment bank Kit Finance, confirmed it had defaulted on some short-term obligations and was in negotiations to be rescued by a strategic investor.”

For good reasons, people are worried about what is happening in the United States. America remains the world’s largest economy and, therefore, a slowdown in the U.S. has negative consequences elsewhere. There is a difference now, however. It used to be that there were few other places to turn when the U.S. economy went south, today — thanks to globalization — there are alternatives. In fact, globalization is even helping the situation in the U.S. The weak dollar has made U.S. products cheaper and, as a result, America’s trade deficit has been falling. This spike in exports has helped the U.S. economy ride out the credit crisis much more easily than it otherwise could have. It also shows that a total collapse of the commodity market is unlikely, but people in Russia apparently aren’t taking that chance.

“Russia’s big oil producers have suffered some of the market’s sharpest declines. Analysts said shares have fallen much faster than the drop in oil prices should dictate. Stock in the state gas and oil giant Gazprom, for example, has plunged below the level it first traded at in 2005 when foreigners were allowed to invest in the company and oil was trading at about $40 a barrel. Even after the dramatic retreat of the past two months, oil was trading at about $97 a barrel Wednesday [17 September]. ‘The market is pricing in a total collapse of commodity prices,’ said James Fenkner, managing partner of Red Star Asset Management. ‘That’s certainly possible with demand down in the States, but growth in Asia could also continue to support prices.’ The crisis, which has been limited to the stock market and the banking system, has been felt primarily by Russia’s wealthy, and there have been no signs of bank runs. But analysts warned that the crisis could spread quickly to other sectors if not contained, noting that rising inflation this year has eaten away at the incomes of ordinary Russians. One of the most vulnerable to tightening access to credit might be Russia’s booming real estate industry. In a possible sign of trouble, the Mirax Group, a developer building Europe’s largest skyscraper on a Moscow river embankment, announced Wednesday that it was putting all new projects on hold because of the crisis.”

Incompetence, corruption, and greed could certainly spawn crises elsewhere in the world just like it has on Wall Street. Sound investment decisions and reasonable regulations, however, can help prevent similar crises elsewhere. It would be good for the world to see that they can ride out a crisis in the U.S. and still prosper. As emerging market countries continue to account for more and more of the global GDP, hiccoughs in the U.S. economy will less devastating to others. Bubbles created by irrational exuberance (or simple greed) are destined to bust. This is a good lesson for emerging market economies to learn. They should carefully watch events unfolding on Wall Street, but they shouldn’t panic.