Tuesday, October 28, 2008

Emerging Markets, Submerging

George Soros, whom I greatly respect for his seminal work The Alchemy of Finance, writes that developing countries need to strengthen the IMF's credit facility to keep emerging markets liquid:

In recent days there has been a general flight for safety from the periphery back to the centre. Currencies have dropped against the dollar and the yen, some precipitously. Interest rates and credit default premiums have soared and stock markets crashed. Margin calls have proliferated and spread to stock markets in the US and Europe, raising the spectre of renewed panic.

The problem with his proposal is that the West may not have a whole lot of liquidity to spare after backstopping their own economies:

Western Europe is on the brink of a recession, exacerbating problems for neighboring emerging economies, which were scorched by investors dumping riskier assets in a flight to safety. Hungary, which first drew up next year's budget expecting 3 percent growth, may now face contraction.

Even if the U.S. takes the lead in bucking up the IMF, Europe may not be able to follow suit. U.S. leadership won't mean much if future revisions to Bretton Woods put more authority in non-U.S. hands. Furthermore, Mr. Soros may be ignoring the role that U.S. regulators have already played in accelerating the spread of the credit crunch to emerging markets:

So the US authorities should have known - and presumably did know - that by allowing Morgan Stanley and Goldman to become banks they were in effect forcing a serious contraction in the hedge-fund industry, which in turn would lead to sales of all manner of assets held by hedge funds and precipitate turmoil throughout the financial economy.

The article points out that curtailment of prime brokerage activity, with the concomitant collapse of leverage available to hedge funds, helped drain liquidity from emerging markets. With banks hoarding the capital they've been handed so far under TARP, there is zero reason to think that additional credit for the IMF will be loaned to companies in emerging markets that need it.

Does Mr. Soros have long exposure to emerging markets that he's trying to salvage? Maybe he and Jim Rogers should talk privately with some Asian sovereign wealth funds and ask them for capital infusions instead of looking to the tapped-out West. SWFs have been disappointed with the stakes they've taken recently in U.S. banks and brokerages. They may have better luck shopping closer to home.

Nota bene: Anthon J. Alfidi holds uncovered short calls on VWO because he is bearish on emerging makets.