New on FinoLib · Volume I: Global Economy
I have added a new article to FinoLib, my finance education website: Emerging Markets Explained: Capital-Flow Stories by Region, part of Volume I: Global Economy. This page gives you the core of the topic in expert but plain language; the full article goes much deeper.
The idea in plain words
Emerging markets grow on foreign capital and suffer when it stops. Debts in dollars against income in local currency turn a falling currency into insolvency.
Key points
■A firm that borrows $10 million when a dollar costs 25 local units owes 250 million against 300 million of revenue; when the currency falls to 40 per dollar the debt becomes 400 million and the firm is insolvent with…
■On July 2, 1997, Thailand gave up defending the baht’s dollar peg, and the crisis ran through Malaysia, the Philippines, Indonesia, Hong Kong and South Korea until the end of 1998.
■The international community lent $118 billion to Thailand, Indonesia and South Korea.
■Asia answered 1997 with reserves: Korea’s rose from $20.5 billion to $436.6 billion.
A closer look
The chapters so far followed countries one by one. Most of the rest of the world is easier to read as a set of capital-flow stories, because the same sequence repeats. Foreign investors, hunting for yield when rates in rich countries are low, lend in dollars or buy local assets. The inflow lifts growth and the currency. Then US rates rise, the dollar strengthens, or a local shock hits, and the money stops (a sudden stop), the currency falls, and every dollar debt costs more local currency to repay. Section 9.4 told that sequence for a country that defaulted, Section 0.10: How a Currency’s Value Is Determined — and Who Does It for the traders who borrow cheap currencies to buy dear ones (the carry trade), and Section 1.20: The Accounting of an Economy for the trade-off behind it, the impossible trinity. This chapter follows four regions through it.
The lesson governments drew was blunt: never again depend on an emergency lender’s terms. Emerging Asia rebuilt its reserves on a scale no earlier generation had held:
A worked example
Trace the Chain — Part 9 Thought Experiments
1. China’s property bust cuts household spending. Trace the effect on German carmakers, Australian iron ore, and Indian pharma exports — three different transmission channels. 2. Why could Japan run debt above 200% of GDP for decades while Sri Lanka defaulted at about 116% in 2022? (Your answer must contain the words “own currency” and “foreign creditors.”) 3. If Greece had kept the drachma in 2010, what would devaluation have done that austerity couldn’t? What would it have cost instead? 4. A neighboring country’s reserves fall below one month of imports. As India’s finance minister, list your first three moves — then compare with what India actually did in 2022. 5.
Under the hood
Under the Hood: Why a Falling Currency Turns a Healthy Borrower Insolvent
The engine of every story below is a currency mismatch: debts in dollars, income in local currency. The numbers here are illustrative. A firm borrows $10 million when 1 dollar costs 25 units of local currency, so it owes 10,000,000 × 25 = 250 million local units. Its revenue is 300 million local units a year, so it is solvent with 50 million to spare. The currency then falls to 40 per dollar, a 40 ÷ 25 − 1 = 60% rise in the dollar’s price.
The Simple Version
Emerging economies grow on other people’s money, and that money can leave faster than it came. Each region in this chapter is a different answer to one question: how do you borrow from the world without handing the world a lever over you? Asia answered with piles of reserves, the Gulf with funds built from oil, Africa learned it the hard way through dollar bonds, and Latin America tried to borrow credibility by tying itself to the dollar.
When This Breaks: A Peg Defended With Borrowed Dollars
A peg works only while the central bank can sell dollars to anyone who wants to leave. Each sale shrinks reserves, and traders who see reserves falling sell first, which speeds the drain. Korea’s cover of 1.4 months of imports at the end of 1997 left almost no time.
Recap
Emerging markets grow on foreign capital and suffer when it stops: debts in dollars against income in local currency turn a falling currency into insolvency. Asia answered 1997 with reserves (Korea’s rose from $20.5 billion to $436.6 billion), the Gulf converts oil dollars into sovereign wealth funds, Zambia and Ghana show the Eurobond cycle and restructuring, and Latin America’s dollarized and currency-board economies show the cost of borrowed credibility.
What the full article covers
The full article includes worked examples, a look under the hood at the mechanics, a recap, a reveal-on-click quiz and the official sources behind every figure.
Volume I: Global Economy
Read the full article on FinoLib
The complete article, Emerging Markets Explained: Capital-Flow Stories by Region, with every worked example, diagram, quiz and source, is free to read in Volume I, Global Economy on finolib.com.
Explore the Finance Education Series: Vol. II — Capital Markets · Vol. I — Global Economy · Vol. III — Finance Encyclopedia · Vol. IV — Finance Careers · Vol. V — Personal Finance