Revisiting Emerging Markets

Robert Swift revisits the Emerging Markets conversation in light of recent foreign exchange developments.

We wrote recently that Emerging Markets were especially dangerous for Australian based investors. We include the link to that article here.

We revisit that so soon because emerging markets and some emerging market currencies have been hit hard by what we feared – a reassessment of the sustainability of inward capital flows.
 
Since July there has been a serious sell off in many emerging market currencies but most notably in the countries which are heavily indebted. This currency sell off has also included the Australian $ which is effectively a currency always likely to move in line with that of other heavily indebted countries. We show the relative currency performance of selected currencies against the US$ since our previous article in the bar chart below. As we thought, the A$ fallen in line with other currencies from heavily indebted countries such as Turkey. Notably the Chinese currency, the Rmb, has been more resilient and outperformed the A$ and the Indian Rupee; everyone’s favourite emerging market currently.

Source: Thomson Reuters

We also show the extent to which Australia is heavily reliant on foreigners for capital. This is what concerned us two months ago. Years of current account deficits have resulted in a reliance on foreigners’ to provide capital. This is always likely to make the Australian $ vulnerable to a sell-off, at exactly the same time as other (emerging market) currencies decline. This is what makes certain emerging markets a bad investment decision for Australians.
 
Note how Australia’s negative Net International Investment Position is as parlous as Turkey’s. It is no coincidence that the Yen, backed by a Japanese economy which is NOT a debtor nation, but a creditor nation, has been resilient against the US$ and the A$.
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To a lesser extent so has the Rmb been one of the stronger emerging market currencies.

We now expect inflation to accelerate rapidly in the countries which have seen these large currency declines. This will not be helpful. We were, and are, mystified by those people who believe we need inflation to ‘return’ for the health of the global economy. We really don’t believe it will be helpful at all!

If you care to re-read what we wrote about this, then this is attached via this link here.