Before the alternative investment community goes into collective apoplexy over the title of this article, it is important to look closely at the repercussions now facing both the emerging markets (EM) and the West as the Fed’s money printing spigot begins to slow down. Almost immediately after the central bank’s taper was implemented in January, hot money began pulling out of the emerging markets which it had propped up over the past 3-5 years, and is now causing incredible chaos in the bond, currency, and equity markets of these countries.
The primary reason they are called emerging markets is because they are economies that sit just outside the G-7 and sometimes G-20 levels of GDP, but are fundamentally ready to take the next steps with the right infusion of foreign and venture capital. And with the Fed’s QE ponzi scheme specifically positioned to keep the velocity of money outside the U.S. economy, banks and multi-national corporations needed new places to put ZIRP money to use, and those places became the emerging markets.
However, the problem with using hot money in an emerging market is that the lenders are only interested in short-term returns, and not in the long-term creation of a stable and growing economy. Thus when the proverbial ‘margin calls’ in the West started to occur with greater frequency, the first places banks and investment firms looked to liquidate was with their holdings vested in markets outside of the U.S..
John Mauldin: The narrative right now is, the Fed is going to tighten. And the market sees this as there is an end to this largesse. And so, the money that was flowing into the emerging markets is now starting to flow out.
And it’s just hot money. In fact, the head of the central bank of India was interviewed recently on Bloomberg, and he banged the table hotly and said, ‘central banks have let us down. You’re not playing the game properly, and you’re putting us in situations where we’re going to be forced to react, and you’re not going to like what we do.’
For all intensive purposes he said were going to put on capital controls. Because if you look now at the countries that don’t have volatility right now, they are the ones who have capital controls. – John Mauldin, King World News
Capital controls placed on foreigners and foreign investments are much different than capital controls placed on a nation’s citizenry. The primary purpose of this form of capital control is to keep invested money in country for the duration of the contract or through the date of loan maturity. An example of this would be a contract for the lending of money over a 10-year period for any given entrepreneurial venture, and then telling the client they are cutting off the funds four years into the deal. Now imagine this on a scale of hundreds of billions or trillions of dollars and you can instantly see how the removal of this much equity, credit lines, or direct access to cash could cripple a nation that had planned for, and relied upon those fund remaining through maturity to complete a project or venture that could eventually become self-sustaining.
It is interesting to note that when China lends money, or enters into a contract with a 2nd world or emerging market country, they not only build a permanent presence there, but quite often, they pay for it with upfront cash, or with AAA liquid collateral such as U.S. Treasuries. There is not the intention by China of using the country’s markets as a get rich quick scheme based on their investing cheap money from central bank printing, but instead, their focus has always been to create a long-term presence and partnership that over time, will help build and grow that nation’s economy.
The problem with a global economy is that contrary to the rhetoric, not all nations and financial systems are equal. The wealthy and powerful nations with nearly unlimited resources will always try to exploit smaller economies with the enticement of cheap money. However, reliance upon foreign capital from any source places them in the disadvantaged position of being a slave to the lender, and like the way the IMF uses money to force nation’s into following their view of monetary policy, emerging markets may have to learn to play hardball with the West, and impose capital controls on foreign investors to ensure their own assets remain stable despite the economic shifts and crises that may take shape in the banking systems of their foreign lenders.