The G8, the bond bubble and emerging threats

A policeman walks past a sign pointing to the Lough Erne Resort - location of the G8 summit The G8 gathering in Northern Ireland is unlikely to excite global markets

G8 leaders meeting in Northern Ireland this week can hardly ignore the ructions in financial markets, though they are not really supposed to do anything about them. These days, the big decisions about the future of the world economy are supposed to be left to the G20.

But when it comes to the global bond market, the real power lies not with the G8, or the G20 - but with the Fed. It's the US central bank that investors will be listening to most closely this week, when it concludes its policy meeting on Wednesday.

How and when the US central bank starts to unwind the incredible support it has been giving to the US and global economy will be the big story in financial markets for months and years to come (for more on this see my earlier blog).

There will surely be many more bumps on this road. But for now, at least, the investors and analysts I hear from don't seem to think the US central bank will let the panic in the US bond market get out of hand - or go too far ahead of the recovery in the real economy. There's a similar air of cautious optimism in the UK - though, as Robert Peston has pointed out, people are understandably less relaxed in other parts of Europe.

The mood in many emerging market economies is not relaxed at all. All the talk there is of a "sudden stop" in capital inflows - and what that would do to their domestic economies. And for good reason, because it is in these countries that a lot of the cheap liquidity pumped out by Western central banks has ended up.

A recent report from Morgan Stanley reminds us how big the numbers are. They point out that the market value of equity in the main emerging market stock markets has risen from $570bn in early 2003 to $3,730bn.

There has also been an explosion in developed country demand for these countries' domestic bonds, with cumulative investments of about $400bn since 2010, according to the same report.

Emerging market currencies have been tumbling since the ructions in global bond markets began. This comes as welcome relief to some, like Israel, who have not enjoyed their currency being so popular with international investors.

But, to others, the change in market mood poses a real threat, especially countries that are still heavily dependent on foreign borrowing, in currencies that they do not control (usually dollars).

The Indian central bank declined to cut interest rates today - partly thanks to fears that the falling value of the rupee would lead to domestic inflation getting out of hand. Many other emerging market central banks could face the same dilemma in the coming months, caught between easing policy to support the domestic economy, and raising interest rates to limit inflation and defend the currency.

Who is most exposed to what economists call a "sudden shock" - a big rush out of emerging markets, as the flood of cheap liquidity in US and European markets begins to dry up?

Every analyst has their own list, but if you look at who is most dependent on borrowing from global investors, in foreign currency, and who has seen the biggest run up in domestic markets, Morgan Stanley says Brazil, Mexico, South Africa, Turkey, and Ukraine look most exposed, with Argentina, Hungary, Indonesia and Poland considered "borderline". Safest, in their view, are China, Israel, Russia and Peru.

We've got so used to financial crises happening in rich developed markets, you might say a good old fashioned emerging market crisis is long overdue. But to many it will seem a rough kind of justice, if the people most affected by the end of loose money policies in the US and Europe are in countries that those policies were never really designed to help.

Stephanie Flanders Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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  • rate this

    Comment number 18.

    US is Banana Republic” - bankrupt country, world’s biggest debtor to foreign creditors. National debt is over US$16.805 TRILLION. When we include unfunded liabilities = debt is over US$100 TRILLION = impossible to repay! American bonds issued by US treasury are “Junk”.
    Main reason: foreign creditors continue buying = stupid corrupt governments just don’t understand how scam works.

  • rate this

    Comment number 17.

    12 "Sound of can kicking.."

    The problem is that there is an enormous chasm to bridge and there is no bridge to return the global economy to reality.

    We have wasted 5 (actually 10+) years going the wrong way and doing the wrong thing.

    The idiots will have to be sacked en-mass before reality can dawn on the regulators.

    Raise the price of money NOW - any delay will make things far far worse.

  • Comment number 16.

    All this user's posts have been removed.Why?

  • rate this

    Comment number 15.

    Surely rates must be raised after 6 years of manipulated CB rates.
    If not savings and pensions will fail in a few years..

  • rate this

    Comment number 14.

    The economic idiots in charge clearly have no education is basic economics or how capitalism WORKS!

    Money MUST always have a positive price or the whole edifice of capitalism collapses. (EXACTLY the present situation - as predicted.)

    The bond, equity (&house price) bubble results directly from QE & zero Interest rates. The people are idiots & totally ignorant of how to run the economy.

  • rate this

    Comment number 13.

    So another unintended consequence of QE building up and yet in the developed countries many show no real gain in financial consolidation. One starts to think about the possible political implications for the emerging markets countries of a sudden shock. Post competition market global capitalism is not delivering for an ever larger number of people (not that it did much before)

  • rate this

    Comment number 12.

    Have just checked out the latest bonds and gilts. The returns being promised are pure science fiction. Governments must be really desperate to raise funds based on that evidence. No economy is strong enough to be able to achieve these returns. Governments will have to issue more unsustainable bonds to cover these unsustainable bonds. Sound of can kicked further down road.

  • rate this

    Comment number 11.

    Continuing to highlight just how bust the HFT derivatives fueled Ponzi was by 2008 - no matter how much central banks throw at the problem, they remain Too Bust To Save

    Such highly leveraged positions won't be gently unwound, it never works that way

  • rate this

    Comment number 10.

    Is it me or is there somthing wrong with this system,
    It is calles Capitalism but they are only creating Debt?????

    time for a change either by choice or by natural correction.

  • rate this

    Comment number 9.

    One PONZI scheme. For buying. Several previous owners. Several (billion) previous mug punters.

  • rate this

    Comment number 8.

    Lets hope it will be a path to a real better situation of high interest rates deterring most lending. Money should not be cheap, or it is wasted, and lost, and we end up here. Crash the house market, (after the election of course, mad subsidy for it now set for electioneering reasons) never do the right thing before self interest in power and sinecures!

  • rate this

    Comment number 7.

    That's imperialism in the age of finance capital.
    The big difference to 100 years ago is the labour 'aristocracy' of the developed countries are being impoverished.

  • rate this

    Comment number 6.

    Governments have financed their spending with borrowed money & they are dependant on borrowing more. UK borrowed 120 billion each of last two years & is likely to need 100 billion next year. Debt in UK excl financial intv over 75% of GDP; much worse elsewhere. Printing more money is no solution. Someone somewhere ultimately is going to have to suffer the loss then watch the house of cards fall.

  • rate this

    Comment number 5.

    It doesn't take a great brain to work out that it has been the Fed that has been feeding these so-called developing markets with the funds to sustain their booms. No wonder Home Town USA is in such poor shape.

    I just wonder how much of the UK QE has off-shored in the same way.

    The concept of the nation-state with its national economy is now utterly out of date.

  • rate this

    Comment number 4.

    "There is nothing either good or bad, but thinking makes it so"

    Shakespeare; Hamlet

  • rate this

    Comment number 3.

    Nevermind the Bond Bubble.....

    ....more important is the Fossil Fuel Bubble.....

    ....values of companies therein are based on being to extract & burn all their known reserves.....

    ...but only a quarter, tops, can be burnt without runaway global warming.....

  • rate this

    Comment number 2.

    What a fiasco. All that money printing has created a 'room of mirrors', distorting our vision of the market all over the place. And what your highlighting Steph is the consequences. The underlying problems of debt deflation, and exceesive private debt levels have not been fixed.

  • rate this

    Comment number 1.

    "I'm forever blowing bubbles....."


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