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What Would it Take to End the Emerging Market Crisis? by Kathy Lien

What Would it Take to End the Emerging Market Crisis?

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management

Over the past 2 weeks we have seen how much damage the turmoil in emerging market countries can have on the assets of developed nations. Investors flocked into the safety of the U.S. dollar and Japanese Yen, as the Argentinian Peso (ARS), Turkish Lira (TRY), South African Rand (ZAR), Russian Ruble (RUB) and Hungarian Forint (HUF) dropped to fresh lows.  Since the beginning of year the ARS lost over 18% of its value versus the dollar while the other currencies fell more than 5%. In the past 6 months, those losses have reached approximately 30% for the ARS and 10% for the ZAR and TRY. A 10% decline in a currency’s value borders on a crisis but a 30% decline is a catastrophe that sounds the alarms inside the central bank.  Unfortunately, the crisis in emerging markets spilled over to developed assets with the EUR/USD dropping from a high of 1.37 to a low of 1.3490, USD/JPY falling from 105 to 101.75 and the Dow Jones Industrial Average incurring over 650 points in losses over the past week.  Given the impact of the crisis in emerging markets on G10 currencies and other assets, an end to the turmoil in EM nations will bring relief to financial markets around the world.

The emerging market crisis won’t end by itself because massive current account deficits, political troubles or the lack of investor confidence are not problems that can be resolved easily especially when situation is made worse by the Federal Reserve’s policies.  Of course, emerging market central banks are not sitting by idly.  They have raised interest rates, devalued their currencies and loosened capital controls.  Higher interest rates is generally the first strategy that central banks use to defend their currencies but as we have seen this week with the U-turn in the Turkish Lira and sell-off in the South African Rand, it is not always successful. To draw in foreign investors, the compensation in interest rates needs to exceed the potential decline in the currency.

While the situation today isn’t as dire as the 80s and 90s, the resolution to the crises in Mexico, Asia, Russia and Argentina can provide insight into how this crisis could be resolved.  Starting with Mexico, the crisis was caused by excessive borrowing, a weak economy and a sudden devaluation in the currency. It was eventually ended when the U.S. intervened.  President Bill Clinton reasoned that the U.S.’ third largest trading partner had to be helped and his administration arranged for $50 billion worth of loan guarantees from the U.S., Canada, IMF and BIS.  When the Asian Financial crisis began 1997, it spread quickly from Thailand to Indonesia, South Korea, Hong Kong and other major economies in the region.  Unsustainable debt levels and risky lending plunged the region into turmoil and as the contagion spread, U.S. equities hit record lows.  The situation became so severe that the IMF had to step in with massive bailout packages ranging from $40B to $57B for some of the hardest hit nations.  These countries also made major changes in monetary policies that now shape the way they manage their economies.  In 1998, the IMF also stepped in to help resolve the Russian Financial Crisis but the country eventually had to devalue its currency and default on its debt. When Argentina experienced its financial crisis between 1998 and 2002, the IMF was blamed for part of the country’s demise and the only option Argentina had was to default on its debt and devalue its currency.

If today’s crisis were to worsen, coordinated interest rate hikes or devaluation by emerging market nations along with IMF liquidity could be the painful but necessary resolution that these countries need.

Kathy Lien
Kathy Lien

KATHY LIEN is Managing Director and Founding Partner of BKForex Trading Signals and BK Asset Management. Having graduated New York University 4 years early, Kathy started working on Wall St at the age of 18.

Her career started at JPMorgan Chase where she worked on the interbank FX trading desk making markets in foreign exchange and later in the cross markets proprietary trading group where she traded FX spot, options, interest rate derivatives, bonds, equities, and futures. In 2003, Kathy joined FXCM and started, a leading online foreign exchange research portal. As Chief Strategist, she managed a team of analysts dedicated to providing research and commentary on the foreign exchange market. In 2008, Kathy joined Global Futures & Forex Ltd as Director of Currency Research and in 2012, she decided to branch out on her own with Boris Schlossberg to start BK Asset Management.

As an expert on G20 currencies, Kathy is often quoted in financial newspapers worldwide and appears regularly on CNBC. Kathy is an internationally published author of Day Trading & Swing Trading the Currency Market, The Little Book of Currency Trading and Millionaire Traders: How Everyday People Beat Wall Street at its Own Game.