Page 1 of 2 Ask not for whom the bells toll By Chan Akya
Most of you would have heard the old joke about the ethnic minority pointing a
gun to his own head on discovering that his wife is adulterous, upon which she
starts laughing. His reply, the classic "What are you laughing about? You are
next!" is meant to allude to the apparent stupidity of these ethnic minorities
in the context of modern Western society. The Americans craft this joke around
the Mexicans, the Germans about the Turks and the Australians about the
Lebanese.
For a change though, this time around the richer countries in the equation are
actually next in line, as the English are proving so
adeptly by cratering in response to the largely self-inflicted collapse of
Russia. I am however getting ahead of myself.
The collapse of investor confidence in emerging markets can be attributed to a
multiplicity of factors; not the least of which is the global economic decline.
However, the current situation of money leaving these countries wholesale in
favor of dour investments in the developed world such as 0%-yielding
three-month US Treasury Bills, can also be attributed to the self-inflicted
policy mistakes of these poor countries.
Broadly, the countries having the worst possible set of dynamics - as defined
by the inability to secure insurance at any reasonable level - can be further
split into three categories: "can't pay", "won't pay" and "both". There is also
a group of countries that are classified as "neither" but in the parlance of
Western intelligence agencies, let us just call them "collateral damage" and
damn their billion people into the same misery as the billion in the first
three categories. I explain briefly the countries that fall into each category,
some of which may be surprising to the casual reader.
"Can't pay" or Iceland cometh
This group comprises countries whose income sources are far surpassed by their
near-term obligations; in other words these countries owe a lot of people a lot
of money over the next few months and without sufficient external assistance
have no ability to meet those obligations. The main countries are those with
poor economic bases, dependent excessively on a narrow stream of exports;
others have invested way too heavily in the recent past into building up their
pipe dreams that would soon come to naught as the world confronts its greatest
recession in the past 70 years.
Examples of countries in this group include commodity exporters like Kazakhstan
and Ukraine; richer countries with massive gaps between their current cash
reserves and near term obligations, such as Iceland, Korea and Dubai; and a
last group of poor countries that have simply slipped further due to policy
errors that have accelerated the exit of foreign investors - this group
includes South Africa, the Philippines and Sri Lanka.
In all of these cases the key issue is a near-term liquidity squeeze that is a
result of the global nature of the credit crunch that has helped to divert
money away from reasonably creditworthy borrowers to government-backed
borrowers from Western countries including the US and those in Europe. Adding
to their problems is the host of bad investment decisions made locally, ranging
from the overexposure to financial leverage for Iceland and the excessive
property bubble in Dubai.
"Won't pay" or the Chavez trinity
This is the more intriguing group of countries that simply refuse to honor
their external obligations. By and large, these countries have faced changes of
government or have figured out that bankruptcy in these troubled times isn't an
altogether unacceptable option.
True to the form displayed since the 1980s, when Latin America slipped into a
domino pattern of defaulting debt, first off the block this time around was
Ecuador, which declared a self-imposed moratorium on servicing its external
debt payments as its president declared that the "legality" of these foreign
obligations were now in doubt. This was soon followed by the balance of the
Chavez trinity (Bolivia and Venezuela) declaring similar doubts about the
validity of such debt.
Far from being the opening gambit of a tough negotiating position of the sort
that Argentina chose a couple of years ago, the Chavez trinity has attempted to
negate debt purely to heap misery on investors at an inopportune time. They
perhaps wagered that the wave of upcoming defaults would be so great that no
one in particular would remember the actions of the three countries in say 10
years' time.
In so doing though, the Chavez trinity may have well condemned millions of
people in other countries around Latin America, Africa and even Asia to dire
poverty as investors become increasingly skittish at the prospects for other
countries following suit on the example being set by these charlatans. This law
of unintended consequences is the hallmark of anything that Stalinist folks try
to do; attempting to reverse an imagined wrong they almost always end up
creating significant damage to innocent bystanders.
"Both", or long sleeve vs short sleeve
The Belgian practice of amputating natives in Congo to keep the population
quiet has ever since been taken up with relish by African warlords. The phrase
chillingly employed to describe various kinds of amputees is long sleeve (only
the hands chopped) versus short sleeve (arm chopped up to the elbow). Applied
to the world of credit markets, the phrase refers to countries (or companies)
that either promise to repay their creditors much later (long sleeve) or reduce
the principal outstanding significantly in order to keep servicing their debt
(short sleeve).
Currently, this motley group of emerging markets is represented by various
failed states ranging from Zimbabwe to Pakistan (see also
The hottest place in the world, Asia Times Online, December 2, 2008);
however the group could well expand dramatically if some countries that are
currently on the fence such as Bangladesh and Egypt choose to join the fray. In
all these cases, the unifying factor is a substantial amount of maturing debt
that isn't covered by either savings as represented in foreign exchange
reserves or assets available for disposal such as profitable state companies.
A murky set of fundamentals is only made worse by conflicting geostrategic
positions: much as Zimbabwe is precariously balanced between a supportive
Africa and a critical Europe, Pakistan is balanced between belligerent
democracies such as India and the US against supportive Islamic states such as
Saudi Arabia on the other side.
OECD reflections
Much of the above should have been clear to most observers in financial
markets. The main point of the article here is that it is quite easy to draw
parallels between the behavior of countries that are currently in a whole lot
of trouble across emerging markets, and their peers in the group of developed
and nearly developed countries that constitute the Organization of Economic
Cooperation and Development (OECD). The main factor is the degree of tilt, but
in every case very similar arguments can be made about the decline seen in
emerging markets spreading rather quickly to a similarly afflicted peer in the
OECD group.
When I first started over a year ago writing about the problems for Europe,
some angry correspondents challenged me to the financial equivalent of a duel -
betting for example that the scale of damage in the US would be irreparable
while Europe emerged relatively unscathed from the carnage. Most recent data
from the continent would suggest that this is a pipedream; if anything Europe
appears to be headed for a deeper and longer-term abyss than any other part of
the world.
In the "can't pay" group of OECD, we have countries ranging from the UK to
Switzerland (see
Europe's death by guarantee, October 11, 2008), wherein the sheer
volume of near-term obligations assumed by the banking sector and thereon by
the state could well overwhelm the country's ability to repay its debt. For the
UK, the decline of its banks due to excessive leverage came about last year.
Since then, the country's efforts at securing an economic recovery have been
frustrated by, of all sources, Russia.
In cracking down upon the country's corporate elite, the so-called oligarchs,
Russia's then president and now Prime Minister Vladimir Putin badly
miscalculated. The actions have helped to
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