Dear,
As the Tapering has started, instability has arrived to the Financial Markets
This is not a surprise; as liquidity is dried from the system risky assets become less attractive.
This is just the first step in the process of normalizing the monetary policy, the key question is how deep the consequences will be at the end of it.
Maybe we can learn something from recent history.
Subprime crisis started on February 2007, as interest rates began to raise some borrowers were unable to refinance and housing prices started to drop moderately.
At the time, economy was performing well and credit kept flowing, the stock market recovered quickly and the subprime crisis was described as a Storm in a Teacup.
One year and half later the Financial System faced the biggest crash since the Great Depression.
In my opinion, there’re similarities between February 2007 and 2014 events that deserve to be analyzed.
Last years' liquidity injections of most of the Central Banks (Bank of England, FED, Bank of Japan, etc) have reduced drastically the interest rates and carry trade has transferred the liquidity excess to the emerging economies, increasing their external debt.
For instance, Brazil external debt has grown from 200000 USD Million to 312021 USD Million in the last 6 years, with most of this capital flowing to real estate investment and consumption.
As the economic activity increased, rating improved and local banking systems gave more loans increasing their leverage. Again, most of this capital flowed to real estate investment increasing property valuations.
Additionally, in some countries, like China, shadow banking has grown exponentially, making very difficult the estimation of the size of the problem. By the way, as it happened with the estimation of the size of the Collateralized Debt Obligations problem of the US Subprime Crisis.
At you know, historically, this is the root cause of credit and real estate bubbles with very bad consequences. Please, spend ten minutes watching the video below.
Most of the emerging countries economies depend on the export of commodities, whose prices also rise during the monetary expansion cycle. As the cycle ends, commodities prices are dropping increasing their trade deficit.
In a globalized world capitals can flow very quickly in and out of a country; this is what we've seen in the last weeks with the logical impact in the Foreign Exchange markets. For instance Turkish Lira dropped by 10% in the last 2 weeks of January, and nearly 30% in the last 6 months.
Trying to stop capitals flight, some central banks have raised interest rates but this is likely going to slow down the economy, increasing the probability of busting the credit bubble.
Someone would say that Man is the only animal that trips twice over the same stone, but the reality is that as we’re still in a financial system oriented to volume, history repeats itself,
But for how long?
Looking forward to read your opinions.
Kindest Regards,
Ferran.
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