As I prepare to step down from Pimco at the end of March, emerging markets are once again in the news for all the wrong reasons. In Argentina the currency has collapsed, Thailand and Ukraine are riven with political conflict, and Turkey is shaky.
These developments are reminiscent of the turmoil in January 1998 when I first moved to the private financial sector after 15 years at the International Monetary Fund. Then, Thailand was reeling, South Korea was on the ropes, and both Russia and Argentina were on their way to sovereign defaults.
A recurrence of the blues in emerging markets is not what conventional wisdom expected just a short while ago. For years experts had argued that these once-ailing economies had grown strong. Bank balance sheets had been strengthened. International reserves were much larger and government debt lower. Institutions were no longer financing themselves by issuing lots of short term debt that had to be repeatedly refinanced. Governments had enacted sensible reforms. Even in the harsh winds of the 2008 crisis, the emerging world did not catch a dreadful cold.
Excessive enthusiasm for emerging markets is far from the only intellectual fashion that I have seen come and go during the past 16 years. Another was the view that western central banks possessed all the tools necessary to secure a great economic and financial moderation; one that guarantees sustained growth, jobs and price stability. But it is in characterising the role of banks in a modern market economy that commentators have been at their most faddish.
At one time a largely unfettered banking system was seen as providing the most efficient way to channel funds to productive investments that create jobs and prosperity. Since banks were thought to embody strong self-correcting forces, they could be regulated with a light touch. These days, however, the banking industry is regarded more as a leech. Banks are seen as suffering from serious institutional and human imperfections. Their main function is the enrichment of insiders. Weak competition helped. Access to emergency bank funding and insurance paid for by taxpayers gave financiers a cushion when the music stopped. This, anyway, is the currently fashionable view. It, too, is an old one. It prevailed in the 1980s when western banks had to be bailed out after an irresponsible lending spree in Latin America. The 2008 crisis has given it new life.
In some ways today’s financial sector is little different from the one I first got to know decades ago. Markets still get overexcited when things are going well, only to go into a torpor when the skies darken. If anything, an even bigger amount of money turns on significant mood swings, threatening at times to tear the pendulum off its pivot.
Human behaviour plays a role here. Market participants, whether in banks or asset management, have their comfort zones and gut reactions. They are influenced by the quarterly earnings ritual and ever-shorter performance measurement periods. And they move in herds.
“A sound banker is not one who foresees danger and avoids it,” wrote John Maynard Keynes, “but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.” For too many banks, it still makes more sense to risk failing conventionally than try to succeed unconventionally.
Then there is the influence of internal market dynamics. Market participants react to one another’s trades in ways that cause movements in asset prices that do not seem to reflect their underlying worth.
Innovation and financial globalisation have played a part. It was once difficult for investors to make bets on far-flung corners of the world economy, such as Kazakh banks and Nigerian breweries. Now they can do so through exchange traded funds listed on western stock exchanges. In good times, this helps capital reach more places faster. But it can also make markets more volatile, and make it easier for instability to spread.
Emerging markets are particularly vulnerable to this phenomenon. They are far more reliant on flighty foreign money – unlike western markets, which are deep with capital from domestic savers. This accentuates both the ups and downs.
Financial upheavals reverberate in the real economy. In moments of excessive euphoria, credit flows too freely, bad loans are made and currency appreciation makes domestic producers less competitive. When the tide of money suddenly reverses, the consequences can include a credit crunch, recession and, in the worst cases, widespread insolvency.
Yet not everything has gone full circle. Regulators and shareholders no longer allow banks to make such risky bets, even though they hold more capital. Instead, more credit is extended by institutions that have less systemic importance, and can more easily be allowed to fail. Central banks have found quicker ways to deal with malfunctioning markets. And many more trades now take place under the spotlight of public exchanges.
On the surface, today’s financial system appears much more sophisticated than the one I joined 16 years ago. But because basic human behaviours remain the same, some of its underlying characteristics have not changed much. Today’s banks are still capable of both doing good and also causing damage. Prompted by regulators and public opinion, they have learnt from mistakes. But if they are to strike that still-elusive balance between efficiency, innovation and soundness, they have much left to learn.
Mohamed El-Erian
Fonte: FT
Fonte: FT
