We have had two much more serious financial crises since the emerging market meltdown of 1998. Yet, those who lived through that crisis will remember how quickly it spread across Asia, Russia and Latin America, and how seriously it devastated U.S. financial investors, causing a quick and disastrous failure at Long-Term Capital Management.
A lot has changed since 1998. Particularly over the last decade, emerging markets – even those on the periphery – have become much more mainstream investments with every financial manager, including many who have never left Tulsa, telling their customers that they need to have a healthy allocation to emerging markets.
And, investors and funds are investing in more than just sovereigns. They are investing, either directly or through funds, in debt that is issued directly by companies in these countries. Often, these companies hold higher credit ratings than the sovereigns where they are based.
The debt that is issued has also transformed dramatically since 1998. It is now primarily US dollar denominated. While that is great for a US dollar investor, it can be a devastating liability on the books of a company that operates in a non-US currency. A company, for example, that is operating in Turkey may have issued US dollar debt in the global markets while the Turkish Lira traded at 60 cents two years ago. Today, that company faces a Lira trading at 27 cents, and serving that debt, or repaying it, is more than twice as costly.
Now, with any luck that company in Turkey (or Vietnam or India) may also have revenues from exports, protecting it from being wholly destroyed by the drop of its domestic currency. (With even greater luck it is exporting commodities, as opposed to finished product, but that isn’t always the case and commodity prices too have fallen). But, the US dollar is so significantly outperforming other major industrial currencies that, unless those exports are directly to the US only, the ability to match income with liabilities will be greatly diminished.
In other words, companies in developing countries are facing extraordinary pressures again due to the precipitous drop in the value of its local currency. And, the longer that the current state of the currencies remains without a rise, the more these pressures will build up and before quickly affect emerging markets at large, much as they did in 1998.
Now, an emerging market meltdown can be avoided if the strength of the US dollar recedes. But, the likelihood is that in 2017, the US dollar will stay at current levels, and many, including Byron Wien, predict even significantly greater US dollar strength versus the Euro and the British Pound. At the same time, nobody is predicting that commodity prices will return quickly to their levels of just a few short years ago.
Unless currencies and commodities move in their favor, with the backdrop of Brexit, Trumputin and virtually all other major industrialized economies turning inward, an emerging market meltdown can happen at any time.