The ‘Fragile Five’ crumble as the US

The US Federal Reserve has been printing money (quantitative easing) for quite some time to lend out to the US government (i.e., to purchase its “bonds”). Because so much money is being made available for it to borrow, the government only needs to offer minimal, below inflation, rates of interest, which makes the bonds unattractive to investors. The Fed’s reason for doing this is to help US capitalism in two ways: to reduce the exchange rate of the dollar, thus making US exports cheaper and more competitive; and at the same time to boost demand by making borrowing cheaper in the hope that artificially increasing demand will counteract the effects of the crisis of overproduction. Because a devalued dollar also makes US imports more expensive, thus increasing not only the cost of living for the population, but also the production costs of US capitalists (making them less competitive), the bourgeoisie knows it cannot permanently rely on such measures, but hopes to set in train a process that will continue under its own momentum even after quantitative easing is abandoned.

The conduct of capitalist monetary policy is not unlike the game of croquet in Alice in Wonderland, where the balls were hedgehogs, the mallets flamingos and the hoops soldiers: ” The chief difficulty, Alice found at first was in managing her flamingo: she succeeded in getting its body tucked away, comfortably enough, under her arm, with its legs hanging down, but generally, just as she had got its neck nicely straightened out, and was going to give the hedgehog a blow with its head, it would twist itself round and look up in her face … and, when she had got its head down, and was going to begin again, it was very provoking to find that the hedgehog had unrolled itself, and was in the act of crawling away … The players all played at once, without waiting for turns, quarrelling all the while, and fighting for the hedgehogs; and … the Queen was in a furious passion … shouting ‘Off with his head’ … about once a minute”. Likewise those trying to fix the capitalist crisis face a total nightmare, albeit one in which they can get rich at the expense of the poor if they play their cards right, with every step they take causing more problems than those they started out with.

The US Federal Reserve has launched three rounds of quantitative easing programmes since the latest crisis broke out in 2007. In November 2008 it started buying mortgage-backed securities with the effect that the Treasury notes on its balance sheet (i.e., the amount it had lent the US government) had increased from $700-800 billion to $1,750 billion in the four months to March 2009. This figure peaked at $2,100 billion in June 2010. As the loans are repaid the Fed issues yet more bonds with a view to keeping its overall holdings in Treasury notes at the $2,000 billion level.

The second round of quantitative easing began in November 2010 and involved the purchase of $600 billion of Treasury securities. Since this too failed to reverse the crisis of overproduction, a third round of quantitative easing was announced in September 2012, whereby the Fed would purchase mortgage-backed securities to the tune of $40 billion a month, a figure which by December 2012 it was to increase to $85 billion a month. The net effect has been to leave the Fed holding some $4,000 billion of government debt at any given time.

The result of flooding the market with all this liquidity, facilitating cheap loans to business and to consumers, has indeed been to boost demand, facilitate growth in the US (even though miniscule it is better than recession) and to reduce unemployment, which has fallen from 10% to under 7%. In these circumstances, with interest rates at an all-time low, investors in search of a good return, having been driven out of Treasuries, have rushed to seek their fortune on the stock markets and on a variety of overseas investments including the purchase of overseas government bonds, especially in the so-called emerging markets – countries such as South Africa, Turkey, Indonesia, India, Russia, Mexico and Brazil. The result of this is that stock markets have boomed, enabling speculators to make a tidy speculative profit. This has driven US stock markets for instance to a record high, just at a time when underlying economic performance is modest, to say the least. It has also enabled emerging market countries to boom, principally because the relatively low interest rates that they had to pay in order to acquire loan capital made investment worth while since the imperialist financiers’ slice of the profit was for the time being much more modest than had customarily been the case.

All this changed in May last year when the Fed hinted that it was thinking it might ‘taper’ its bond purchasing programme. Even the hint sent investors into a tailspin.

Then, although “The Fed [had] expanded its holdings of Treasury and mortgage-backed securities by $85 billion each month in 2013 in an effort to spur job creation and drive down unemployment “, in December it ” announced that it would cut the volume to $75 billion in January. It said Wednesday that it would further reduce the volume of purchases to $65 billion in February …. It also said it was ‘likely’ to continue the retreat, setting the table for another $10 billion cut at the next meeting of the Fed’s policy committee in March ” (Binyamin Appelbaum, ‘Citing growth, Fed again cuts monthly bond purchases’, New York Times, 29 January 2014).

The Financial Times of 15 January gave a stark warning of the disaster this tapering was likely to mean for developing countries:

“An abrupt unwinding of central bank support for advanced world economies could cause capital flows to emerging markets to contract by as much as 80 per cent, inflicting significant economic damage and throwing some countries into crises, the World Bank has warned…

“It highlights the risk of a repeat on a larger scale of last year’s turmoil in emerging markets after Ben Bernanke , Federal Reserve chairman, first hinted in May at plans to ‘taper’ the central bank’s asset purchase programme. ..

“It adds: ‘Nearly a quarter of developing countries could experience sudden stops in their access to global capital, substantially increasing the probability of economic and financial instability . . . For some countries, the effects of a rapid adjustment in global interest rates and a pullback in capital flows could trigger a balance of payments or domestic financial crisis.’

“Last year’s ‘taper turmoil’, saw yields on 10-year US Treasuries rise by 100 basis points. Investors withdrew $64bn from developing country mutual funds between June and August. Countries such as Brazil, India, Indonesia, Malaysia, Turkey and South Africa saw sharp sell-offs in equity, bond and currency markets” (Ralph Atkins, ‘World Bank warns of capital flow risk to emerging markets’, 15 January 2014).

As investors charged out of emerging markets to avoid inevitable losses, the countries where this effect was first noticed (South Africa, Turkey, Brazil, India and Indonesia) were labelled the ‘Fragile Five’. The number of countries seriously affected, however, is much larger than five, as James Kynge of the Financial Times explains:

Forget the ‘Fragile Five’ …. The list of countries exposed as central banks tighten monetary policy is longer than the moniker suggests.

When judged by their perceived ability to repay short-term foreign borrowings the countries particularly exposed to the fallout of tapering are South Africa, Turkey, Brazil, India, Indonesia, Hungary, Chile and Poland, data processed by Schroders and the Financial Times show…”

He further explains: “One metric increasingly adopted to assess emerging market vulnerability compares the size of a country’s foreign exchange reserves to the sum of its short-term external debt and its current account deficit, called the gross external financing requirement (GEFR).

“This shows that in the second half of last year, Turkey, South Africa, Chile, India and Indonesia had sufficient reserves to cover around just one year of their respective GEFRs, according to the Schroders’ research. Hungary, Brazil and Poland are less exposed, with reserves to cover around two years of GEFR…”

Ultimately, “The crux for many emerging market borrowers – both sovereign and corporate – is that sharp recent depreciations in their national currencies have inflated the local currency values of their hard currency debt, straining repayment capacities. In some cases, the trend of currency softness has yet to run its course, with the South African rand falling to a five-year low of R10.85 to the US dollar on Tuesday” (‘”Fragile Five” falls short as tapering leaves more exposed’, 16 January 2014).

One of the worst affected countries is Turkey . “…Turkey, once hailed as a leading high-growth economy, now has a weak currency and high interest rates. The looming cardiac arrest of the economy comes in a year of local and presidential elections and possibly a general election as well. Fears of political instability are feeding back to the currency markets” (Wolfgang Münchau, ‘Europe will feel the pain of emerging markets’, Financial Times, 2 February 2014).

On 28 January, in an effort to keep capital in the country and prevent a crash in the exchange rate of the Turkish lira, the Turkish government increased the interest rates it was offering on the short term loans on which it depends to keep its expenditure programme running by 4.25 percentage points. South Africa and India too have been forced substantially to increase the interest rates they offers. But still the investors flee. The effects of the twin evils of currency depreciation and high interest rates are of course disastrous :

“Governments and companies in emerging markets are facing steep increases in fuel costs, which threaten to widen trade deficits or curtail economic growth, as a result of recent currency turmoil .

“Although Brent crude oil remains well below its 2008 peak in dollar terms, it is at record levels in South African rand and Turkish lira. In the currencies of India, Indonesia and Brazil – the other so-called ‘fragile five’ economies exposed to large import bills – Brent hit record levels late last year.

“The result is a dilemma for emerging market governments. Either they allow fuel costs to rise, stoking inflation and discouraging consumption, or they absorb higher prices through subsidies, heaping further pressure on already-strained budgets” (Ajan Makan, Ben Bland and Daniel Dombey, ‘Governments in emerging markets face fuel subsidy dilemma’, Financial Times, 2 February 2014).

This uncontrollable turmoil opens the eyes of more and more people to the absurdity of the capitalist system and major social unrest is also likely to be unleashed in the affected countries as their people face a precipitous fall in their standard of living through no fault of their own, strengthening the forces of proletarian revolution.

In the words of Wolfgang Münchau (op.cit.) ,”So much for ‘crisis over'”.