George Athanassakos is a professor of finance and holds the Ben Graham Chair in Value Investing at the Richard Ivey School of Business, University of Western Ontario
Who among central bankers and politicians are in control of the fates of their national economies? This seemingly easy question has no clear answer. Mainly because no one central banker or politician is in control as we are in an age of tyranny imposed by capital markets. Both monetary authorities and politicians seem to respond to the markets rather than the other way around. Strong men are only strong in name. If they do not play by the rules and desires of the markets, they will inevitably pay a price and be humbled.
A case in point is strong man Recep Tayyip Erdogan, the president of Turkey. The currency crisis is most certainly serving him a slice of humble pie.
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After he appointed his son-in-law as treasury and finance minister and subsequently pressured the Central Bank to not raise interest rates, all hell broke loose. The markets punished the Turkish lira, in turn seriously increasing the financing costs of Turkish companies who have built up a lot of U.S. denominated debt. This will have repercussions for the Turkish economy. No matter how long Mr. Erdogan chooses to procrastinate, he will eventually have to bow to the markets or risk a full-blown crisis and political unrest.
Let us also not forget that, in the late 90s, when Thailand’s government decided to abandon the peg of its currency to the U.S. dollar, it caused the emerging markets crisis of 1997-98. In addition to Thailand, affected economies included Indonesia, South Korea, Hong Kong, Malaysia and the Philippines. The crisis forced Asian economies to shape up and fix their finances as well as boost their reserves of foreign currencies. South Korea, as a result went from being one of the biggest borrower nations to one of the world’s biggest savers.
It remains to be seen whether another strong man of our times, US. /president Donald Trump will also be humbled. Mr. Trump appears to be a disruptor of conventional thinking, and the markets seem to support him. That is, of course, as long as things move along. As soon as he goes too far and his trade war-induced tensions start to ruin the global economic party, the markets may punish him and the U.S. economy.
The financial crisis of 2007-09 purported to correct some of the imbalances that were built into the system the years before. The subsequent rescue packages and reforms provided some catharsis to economies around the world. But the catharsis did not go far enough. We are now back to record debt levels and apparent bubbles in most markets. Economies have become addicted to low-interest rates and liquidity infusions.
The U.S Fed is poised to raise interest rates and drain liquidity out of the economy with many key central banks around the world (ECB and Bank of Japan) following suit. One has to wonder: If low interest rates and adequate liquidity are now in danger of disappearing, how will the markets react and what will politicians and central bank governors do? What are central bankers, including U.S. Fed governor Jerome Powell, going to do if a full-blown crisis erupts? Emerging market equities have already declined by over 20 per cent since January 2018 putting a lot of pressure on other economies with the risk of contagion increasing. The markets’ anticipation of higher interest rates and lower liquidity is one of the reasons for the current emerging market crisis, and it is a preamble of things to come. Will central bankers and politicians panic and rush to offer solutions that include lowering interest rates and providing more liquidity? Will, as times before, politicians and central bankers be forced to react and succumb to the tyranny of capital markets? Will they have to bow to market demands and scale back interest rate increases?
In my opinion, the answer is yes, since they are no longer in control. And this has implications for investors with long horizons. There may be no better time to remember the old adage “Buy when there’s blood in the streets, even if the blood is your own.”