The commodity shock could soon bring new problems for the German export economy. The IMF sees a crisis in emerging markets on the horizon, but does not have any solutions to offer. Germany must urgently prepare for this situation.
The autumn meetings of the International Monetary Fund and the World Bank took place; for the first time in 50 years in Latin America. But this event is more serious than in other years. In a balanced and yet with an alarming tone, the IMF has warned of significant stability risks associated with the economic slowdown in China and the crisis in the emerging markets. The economists of the IMF speak in this context of three challenges in its financial stability report; dealing with the past and normalization in the advanced industrial countries, a significant deceleratione in growth in China with feedback effects on the emerging countries and risks to market liquidity.
With respect to advanced industrial countries, the IMF suggests slower but steady growth, adjusting to the situation of the emerging economies and very prudently communicated normalization of monetary policy in the USA. It’s a continuation of expansionary policies, where possible, even more expansionary fiscal policy.
With respect to emerging markets, the fund looks caught in a downturn phase of the credit cycle. Economic growth weakens from an unprecedented credit boom. Falling commodity prices and the risk of a credit contraction in domestic markets reduce the revenue of the corporations in the foreign and domestic economy. Falling currencies increase the problem because these goods must be paid for mainly in dollars. Banks in emerging markets are traditionally protected by a strong deposit base. But due to the exposure of banks and non-financial companies in servicing their debt, they both become vulnerable to shocks.
This leads to the third major problem that of risk of financial shocks and its effects on the financial markets. Here the IMF economists place a significant, hidden liquidity risk for markets. A shock could result in this analysis as according to amplified market movements, which dampen business confidence abruptly. This is a complex phenomenon. Traditional institutional investors such as insurance companies, pension funds fell due to the low interest rates in a plant-emergency and invested increasingly or excessively in risky bonds. Even classic retail funds have great exposure, and may continue to decline. This is a form of an ALM-risk. Another phenomenon is the bond purchases by central banks, which greatly reduce the market liquidity in these segments.
In the market crash of August 24 of this year, high frequency trading moved the S & P futures up after the market closed down in New York by close to 4% upwards. This can help to prevent an expectation induced downward spiral in the short term. But if China triggers a chain of credit events, bankruptcies, payment monitoring, then such interventions can no longer help. The usual recommendations of the IMF (supply-side structural reforms, devaluation etc.) are then inadequate and totally ineffective. Economic policies as well as the corporate sector should be prepared for this potential scenario.
For Germany, the mastermind of the “worst case” scenario has identified three policy options: negative interest rates, reduction or bans on cash and the system-wide “bail-in”. These pioneers include quite a few chief economist renowned central banks like the Bank of England or Treasury.
Source: Business Insider