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Emerging markets face new fallout as U.S. Federal Reserve scales back

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    It's been a rough couple of weeks for some overseas financial markets. That was true again overnight in Europe and Asia, where stocks finished lower. The volatility of late has brought fresh concerns about what's happening in the global economy and the connections with the U.S.

    Jeffrey Brown explores what's behind the jitters and its ripple effects.


    Much of the concern surrounds emerging markets in countries that are now nicknamed the fragile five: Turkey, India, Brazil, South Africa, and Indonesia.

    For its part, here at home, the Dow Jones industrial average is nearing a so-called correction, a drop of 10 percent.

    We look at what's happening with Eswar Prasad, an economist with Cornell University and the Brookings Institution, and author of the new book "The Dollar Trap: How the U.S. Dollar Tightened Its Grip on Global Finance," and Liz Ann Sonders, chief investment strategist for Charles Schwab & Company.

    And, for the record, Charles Schwab is a NewsHour underwriter.

    Well, Eswar Prasad, let me begin with you and let's talk about the emerging market concerns. These have been areas of major growth for some time. So, generally speaking, what's going on with them?

  • ESWAR PRASAD, Cornell University:

    Emerging markets are facing two hits right now, first of all, the Chinese economy, which is a very important trading partner for many of the emerging markets and it's absorbing a lot of the commodities. Looks like it's going down.

    But, more importantly, the prospect of monetary tightening in the U.S., which could lead to an increase in interest rates in the U.S., is causing investors worldwide to start thinking about whether they really want to leave their money in the emerging markets, which look a little riskier and which have uncertain growth prospects.

    And this is laying bare the vulnerabilities in the emerging markets. And the economies that you mentioned all have a common thread running through them. They have large current account deficits, which means that they rely on foreign capital to finance some of their domestic consumption and investment. Many of them have budget deficits that are quite large.

    And most of them are visited by political turmoil, which means that they are unable to take the reforms necessary to put their economies back on the right track. So it's a confluence of a lot of bad things happening at the same time.


    Let me ask.

    Liz Ann Sonders, pick up a little bit first on that on that tie to the U.S., to the Fed in particular. What's the connection?

  • LIZ ANN SONDERS, Charles Schwab:

    Well, we saw it last start last summer when the Fed first started to hint that they would consider tapering their quantitative easing purchases.

    And what had happened prior to that is so much of this liquidity had gone to chase yields, higher yields anywhere in the world. So you saw a lot of money go into emerging markets, in the currency markets, the bond markets and the equity markets. And the fear that the Fed was pulling the punch bowl away started to unwind these trades.

    That calmed when the Fed opted not to do anything in September, but, of course, they not only hinted this time, but actually started tapering. So you start a resurgence of the unwinding of what they sometimes call these carry trades. And that's really what you're seeing. So the infection is more in the financial markets than I think it is at least yet economic contagion into the U.S.


    Well, let me ask Eswar first about the economic fallout in these countries before we get back to the U.S. We're talking about markets. We're talking about currencies. Are we seeing real impact on the streets in these countries?


    It's not as bad as in the periods of the Asian financial crisis in 1997/'98, for instance. Many emerging markets in fact have learned their lessons.

    They have more flexible exchange rates, which means they're not trying to protect a particular level of the currency. They don't have as much external data as they used to have a couple decades ago, and they have much more foreign exchange reserves, which means a lot more protection from financial crises.

    But it is still a very rough road ahead for these emerging markets because now foreign capital has stopped coming in. Well, it is. It just isn't coming in as the same quantities as before, which means they either have to tighten up their own domestic policies, especially budget policies, or they have to reduce their domestic consumption and investment.

    And at the same time, many of these emerging markets are also contending with high inflation and other problems domestically. So they need to fix a lot before they can get their economies back on this high-growth trajectory.


    Well, so, Liz Ann Sonders, given that, then come back to what are the prospects for what we call contagion, right, all of what's happening there bouncing back to us and getting even worse?


    I think somewhat limited, at least into the broader economy.

    There's no question that there are ripple effects and there is some fear that we are potentially seeing a repeat of the late 1990s, although I would agree the differences are important, notably the difference between pegged exchange rates and flexible exchange rates. So I don't think we have that type of scenario.

    But margin debt recently hit in an absolute sense an all-time high. So the contagion sometimes happens when a lot of investors who are starting to lose money in many of these asset classes get margin calls. They have to sell other assets. So that's where the contagion tends to come into play.

    I think it's a short-lived situation. I think we might be somewhat limited in terms of the correction we're going to see. It may have a little bit more to go, but I don't think the bull market is over. But there's a lot of concern that there may be some dead bodies buried, kind of like long-term capital in the late 1990s. And until we settle some of those questions, we probably have some more volatility.


    Dead bodies buried in terms of bad investments around the world.

    What about the U.S. economy? How — what's the interplay now, Liz Ann Sonders, staying with you, as you look at the potential for a correction?


    Well, a little bit of a double whammy for the markets, the U.S. markets anyway, has been the fact that some of the recent economic data has been fairly weak. So about a month ago, we got a very, very weak jobs number.

    On the surface, anyway, it seemed it was highly weather-related. The problem is, the weather hasn't improved, so we have another jobs report coming out later this week. And if it's weak again, even if it's cited as weather being one of the problems, that's still going to send some ripples.

    We had the ISM manufacturing number come out that was quite a bit weaker than expected, also with weather as one of the reasons cited. But — so we have some near-term angst that we're dealing with, uncertainty regarding the economy. And as far as the weather is concerned, speaking from somebody in the Northeast, we're not going to get an answer for some time as to how much of an impact weather has had.


    And, Eswar Prasad, as you watch the world, and especially these emerging countries — economies that we're talking about, it seems like every day there's a different story about a different one of them, and they all have very specific issues, of course.

    But is there — are there one two that you're most focused on to help you and maybe help us think about where we're headed?


    Turkey and Argentina are the most volatile cases because they have enormous political problems. But, in addition, they have fairly significant current account deficits, so they rely on a lot of foreign capital.

    Other countries like India and Brazil are also facing tremendous domestic tensions because they have very high inflation, which means that their central banks need to tighten monetary policy, increase interest rates in order to fight inflation. But that reduces domestic activity.

    So, ultimately, it's going to be a very difficult balancing act for these economies. And for the U.S., it's going to be a mixed blessing. On the one hand, it means more money coming to the U.S. in search of safety, but, on the other hand, the emerging markets have been a very important part of the world economy.

    They now account for about 40 percent of world GDP, so lack of demand from there is not good for the U.S. And if the dollar remains stronger than it ought to be otherwise, that's going to mean less job growth, less exports for the U.S. And right now, when the economy is weak, every little bit helps, and this is going to hurt.


    And, Liz Ann Sonders, just in our last 30 seconds, I have to ask the — so much of this is about big traders, of course, in the markets. What about regular old investors at a time like this? What's the advice?


    Well, the potential good news, if you want to call it that, is that a lot of individual investors have largely stayed out of this market. They have been very skeptical over the last five years.

    So I don't think you have had the mass influx that you might expect, given that we're in a five-year bull market. I do think more of the activity that you're seeing is coming from the institutional side, less so on the individual investor side.

    I think, ultimately, this is a buyable correction, if you want to call it that. So I think we will ultimately be OK, but it's going to be — it's going to be rough for the near term.


    All right, Liz Ann Sonders, Eswar Prasad, thank you both very much.


    Thank you.


    Thank you.

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