posted July 9, 2014
‘Is the Global Economic Crisis Shifting to Emerging Markets?

First published by

Since late 2012 the global economy has been in the process of a long term economic slowdown—in terms of real productive investment, global trade, productivity, as well as other key economic indicators. That slowdown appears irregular over the short run, with some months and quarters up and some down, but a longer term slowing trend is evident nonetheless.

Concurrent with the long term real economy slowing, conditions for a new round of financial instability and a new financial crisis have continued to build globally as well.

Moreover, both the slowing global real economy, and the forces building toward yet another global financial crisis, appear increasingly concentrated in the emerging markets sector of the global economy.

In the following Part 1 of the two-part series on the growing economic problems and instability in emerging market economies, the analysis focuses on how the advanced economies of the USA and Europe are in the process since 2013 of ‘exporting’ their failed economic recoveries to emerging market economies. In Part 2 of the series to follow, analysis will focus on the causes behind the rapidly rising debt and financial instability in the emerging markets economies, including China.

Since the financial crash of 2008 and the global great recession that followed, the global economy has evolved through several stages or phases. The first stage or phase was the general financial crash and deep real economic contraction that occurred worldwide during 2008-09. That crash was centered in the economies of the advanced economies (AEs)—US, Europe, and Japan. The AE-centered crash initially dragged down all the major economic sectors of the world economy in its wake, including initially China and Emerging Market Economies (EMEs).

The second phase, from 2010 to early 2013, was characterized by a dual condition: China and EMEs recovered quickly and robustly beginning 2010, while the AEs either slipped back into multiple recessions or more or less stagnant economic growth.

In the second, 2010-12 phase of the global economy, China and the EMEs economic trajectories differed from the US and AEs due to several factors: first, they were not at the center of the financial crash and they were able to significantly stimulate their economies fiscally to produce real productive investment; second, money and credit was quickly made available from both internal and external sources to enable their real investment, expansion, and recovery. China and EME’s therefore experienced a ‘V-shape’ rapid recovery between 2010-12. China and several major EME economies grew at double digit annual GDP rates, and most other major EMEs in the 5%-10% GDP range during the second phase period.

During the same period, however, Europe experienced a bona fide double dip recession in its real economy. Japan fared even worse, experiencing a triple dip recession from 2010 to 2013. Meanwhile the USA economy experienced weak economic growth, which included three bouts of ‘economic relapses’, defined as a single quarter collapse in GDP to zero growth or less. Relapses occurred in early 2011 and late 2012 in the USA, which narrowly averted slipping into double and triple dip recessions similar to that which impacted Europe and Japan from 2010-13.

This second 2010-2012 phase—characterized by the AEs slipping in and out of recession and near recession while China and EMEs experienced a robust recovery—reflected a global capitalist economy that did not fully or fundamentally recover from the crash of 2008-09. The sharp crash and contraction of 2008-09 merely morphed into a new form during 2010-12, i.e. of continuing long term economic stagnation in the AEs amidst robust growth in China and the EMEs.

Beginning mid-2013, however, the ‘dual’ character of the second phase began to reverse, with China and the EMEs dramatically slowing in terms of real economic growth, as the AEs recovered from recession in early 2013 in both Europe and Japan and began to grow moderately at 1%-2%, and as the USA 1.7% average GDP growth since 2010 rose to a 3% plus GDP rate in the second half of 2013.
In contrast, China’s growth rate began slowing in 2012, from double digit 12%-13% GDP rates to an official 7% in 2014, which many economists consider overestimated and really at 6% or even slightly less. China’s economy has slowed to 7% or less, moreover, despite two rounds of fiscal stimulus in early 2013 and again early 2014. Other EMEs like India, Brazil, Mexico and others— growing well beyond 5% annual rates in the second phase—now slipped beginning 2013 to low single digits percentages at best, while South Africa, Russia, and other EMEs slipped into mild recessions.

There is thus, beginning circa mid-2013, a distinct reversal underway in the global capitalist economy. Once rapidly growing EMEs are now slowing, and once stagnant and declining AEs now stabilizing or even growing at low annual rates instead of experiencing recessions or stagnation. The net result, however, is a still further slowing global economy.

This can be seen in the data for global trade, which declined significantly by late 2013 and even more in 2014. Compared to the first quarter of 2013, world trade in early 2014 rose a mere 1.5% compared with the year earlier. Similarly, global business spending trends show that the 1% decline in global capital spending by corporations in 2013 is projected to continue to decline another 0.5% at least in 2014. As the ‘reversal’ occurs and the third phase of the global economic crisis emerges, the overall global real economy will continue to slow as well.

It is important to understand why this second 2010-2013 phase dual growth scenario has ‘shifted’ or reversed as the global economy now enters a third stage? And also to understand why modest growth in the AEs is about to occur at the expense of a slowing of growth in the EMEs?

Here’s a brief summary answer to these two important points:

When the financial crash and deep contraction of the first phase of the global crisis occurred 2008-09, the US central bank (the Federal Reserve) and the Bank of England quickly injected tens of trillions of dollars and pounds into the global banking system to stem a deeper and more profound collapse. That injection occurred in the form of special auctions, setting private bank borrowing rates at near zero, and by the central banks buying up bad investments from banks and private investors by printing money, a program called ‘quantitative easing’ (QE).

Together these various central bank measures injected conservatively somewhere between $10-$20 trillion in virtually free money into the private banks, both commercial and ‘shadow’ banks. The massive money-liquidity injection effectively ‘bailed them out’. Meanwhile, Congress and the UK Parliament injected further stimulus into nonfinancial corporations by means of tax cuts, subsidies, and other measures. The former bank bailout was supposed to stimulate bank lending to businesses and consumers in order to stimulate the real economy in turn. The legislative measures were supposed to stimulate business and consumer spending. Neither had the intended effect. The AE economies consequently stagnated.

What happened instead was the massive liquidity injections, targeted to both bank and non-bank corporations, were either hoarded as cash on AE bank balance sheets, or invested offshore in EMEs commodity and infrastructure expansion projects, or invested in financial bond, stock, foreign exchange currency, and other securities markets offshore in the EMEs.

In other words, instead of stimulating the AE economies, massive money capital flows went offshore from the AEs to the EMEs stimulating business investment in EMEs in commodities, infrastructure, and other goods producing sectors, as well as in the financial markets of the EMEs. At the same time, as China introduced its own massive 15% of GDP fiscal stimulus package in 2009, thereby boosting its own growth to double digit levels, China demand for EME commodity exports and goods exports escalated as well. The combined money in-flows to EMEs and demand for their products by China and other EMEs, resulted in the robust double digit growth of EMEs in the second phase, 2010-13.
As quantitative evidence of this process, whereas money capital flows into EMEs before 2010 never exceed a cumulative $400 billion, beginning in 2009 money capital inflows to EMEs escalated quickly to $1.5 trillion by 2011 and to $2.5 trillion by 2013. EMEs benefited doubly by developments in the second phase of the global crisis: from the massive money inflows and investments from the central banks, private banks, and investors in the AEs, on the one hand, and from China’s stimulus of 15% of GDP in 2009-10 that resulted in its own record double digit growth and therefore demand for EME exports.

But by 2013 this had all begun to fundamentally change, i.e. to shift and reverse. In the late spring of 2013 it became clear to AE central banks, the Federal Reserve and the Bank of England especially (and to the European Central Bank and Bank of Japan which initiated their own ‘liquidity injection’ policies later in 2012 and 2013, respectively), that massive money capital injections saved their private banking systems—but that same multi-trillions of dollars of liquidity injections did not stimulate their real economies.

Moreover, central bankers were becoming increasingly aware that the tens of trillions of dollars of their liquidity injections from 2009 through 2013 were stimulating financial asset bubbles in their own AE economies—especially in stocks, junk bonds, housing once again, leveraged loans, and CLOs and other derivatives. It also became increasingly clear to AE central bank policy makers that it was not necessary any longer to pump more money capital into their banks. It was perhaps more effective to ‘recall’ the money and liquidity that had previously been provided to AE banks, but had in turn been diverted by those same banks to EMEs and offshore economies, offshore financial markets, and offshore tax havens by AE investors and businesses.

The decision by the Federal Reserve was therefore in early summer 2013 to announce it would soon reduce its QE money injections and consider raising interest rates. Just the announcement that it would consider such action resulted immediately in reverse money flows from the EMEs back to the AE economies.

Capital flight starting flowing out of the EMEs in the summer of 2013 at an alarming rate. EME currencies began to rapidly decline as a result. Investment in-flows into EMEs began drying up. EME stocks and bonds plummeted. Exports slowed. And inflation in imported goods into EMEs rose.
In response to growing capital flight, falling currencies, and declining foreign investment, the EMEs quickly raised their domestic interest rates to stem all the above. It helped some. However, the response of higher domestic interest rates resulted in a slowing of their own domestic economies. And slower EME growth translated into slower global economic growth, as prior referenced data on global trade and capital investment showed.

The capital flows back to the AEs, however, meant a new source of demand for AE stock and bond markets. Foreign reverse cash inflows boosted US and UK stock markets, junk bond markets, and foreign exchange trading in particular to new heights. Money returning also flowed into housing and real estate markets, which experienced a brief modest recovery in the US in 2012-13 and a more rapid growth in the UK, in London property markets in particular.

Somewhat ironically, AE central banks’ 2013 decisions to reduce direct money injections via reducing QE actually served to increase liquidity in the AEs. Pulling back money capital from the EMEs to the AE economies actually stimulated select sectors of AE economies, like real estate. But that same reversal of money capital flows also served to reduce economic activity and growth in the EMEs as well. Growth would be stimulated in the AEs, but at the expense of growth in the EMEs.

However, the process proved initially too disruptive in the early summer of 2013, when the Federal Reserve first mentioned plans to reduce QE and later raise rates as well. The contraction and disruption in the EME economies was occurring too rapidly. The USA Federal Reserve therefore announced quickly a turnabout in July 2013, indicating that it was not really planning to raise rates or reduce QE. The EMEs crisis abated: capital flight slowed, currencies recovered lost value, and EME economies stabilized as well.

The Fed then announced once again in late summer 2013 that it planned to slow its QE injections; EME instability returned. The Fed retreated a second time temporarily in the fall of 2013 as the US Congress’s government shutdown and risks of government bond defaults rose as a possibility. Fed monetary policy and QE was sidelined. After having passed, by year end 2013 thereafter the Fed began its policy of reducing QE injections slowly over coming months. EME instability was on again. And so it has gone ever since over the course of the past year, off and on, on and off, as monetary policy of AE central banks continues to shift and reverse.

What is clear is that the long run policy direction in the AEs, in particular the USA and UK, is to ‘recall’ capital from the EMEs in order to re-stimulate its own inadequate economic recoveries to date. The initial liquidity injections since 2009 have served their purpose: they have more than bailed out the AE banks, commercial and shadow banks alike. They have sent AE stock and bond markets to record heights and profitability for investors. They provided the massive infusion of money capital into EMEs that produced historic offshore investment and profit opportunities for AE multinational companies.

In recalling and bringing money capital back to the economies of the US, UK, Europe and, most recently, Japan the global money capital flow reversals are simultaneously slowing the growth of the EME economies. This long term process is not occurring uni-linearly. It is occurring with stops and starts, temporary reversals, and tactical delays designed to dampen the negative impact too quickly on the EMEs. But the longer term direction is clear: led by their central banks, the AEs are in the process of ‘exporting’ their own five year long stagnant and low growth to the EMEs. As the central banks tighten monetary policy (reduce QE, raise rates, etc.) the EMEs will now grow more slowly as a consequence of capital flight, currency decline, slowing foreign direct investment into their economies, rising inflation, and slowing exports.

EMEs that are especially dependent on exports for growth will be more quickly and more severely impacted by the emerging reversal in global capitalist policy, as the global economy enters its ‘third’ phase or stage more completely in 2014-15. The locus and weak link in the global capitalist economy is thus shifting—from Europe, Japan, and even the USA—to the EMEs. More future volatility in EME financial stock, bonds, currency, and other financial markets will be another outcome.
(Next: In Part 2, how rapidly rising debt in EMEs is also raising financial fragility and instability in EMEs and their financial markets, shifting the likely locus of a future financial instability event and possible financial crash to the emerging markets as well).

~ Dr. Jack Rasmus serves as Chair of the Federal Reserve on the Economy Branch of the Green Shadow Cabinet, and host of the weekly radio show, Alternative Visions, on the Progressive Radio Network in New York. His blog is and twitter handle, @drjackrasmus

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