The COVID-19 pandemic provoked the most abrupt economic downturn of our lifetimes. In addition to the ongoing shocks to supply and demand, international trade has been affected by a reduction in the supply of trade finance.
The rise in net charge-offs, which corresponds to the value of those loans that commercial banks assume that will not be paid, created insufficient liquidity for trade finance, threatening to compromise otherwise-viable trade transactions like commodities’ exchanges. Risk perceptions about non-payment in international trade in March were at the highest levels in a decade, as banks were increasingly reluctant to take on payment risks in many countries where economic conditions were deteriorating.
According to Alan Finkelstein et Victoria Nuguer - Economy researchers, the Global Financial Crisis of 2008-2009 highlighted the role of the banking system as an important propagation mechanism of U.S. financial shocks to emerging economies, where bank credit represents the primary source of formal external financing and the financial shocks in the U.S are essentially transmitted to Emerging Economies via cross-border bank flows.
When rich countries face financial restrictions, they shut down the “liquidity trap” that flows into poorer countries, creating harder exchange terms for less developed nations. It has already happened in the past (2008), and today, considering that the globalization of finance has advanced greatly since the 2000s, we’re observing a much-sophisticated way of shock-propagation.
Despite the problems the coronavirus is causing by paralyzing the real economy, the prices of risky assets recovered after the resounding decline suffered at the beginning of the year as reference interest rates decreased, causing a general relaxation of financial conditions. The quick and vigorous measures adopted by central banks to deal with the strong market tension have sustained player’s behavior, including in emerging markets, where several countries, like Brazil, have turned to buy assets for the first time (on some sort of Quantitative Easing), contributing to the restoration of the liquidity in the system.
Historically, there’s a disconnection between financial markets and the real economy when the environment carries high uncertainties. Such disconnection can compromise the recovery after the COVID-19 if risk-takers lose their appetite, among other vulnerabilities in the financial system that can manifest due to the COVID crisis.
The world has entered an unprecedented age of expansionary monetary policies since the Global Financial Crisis of 2008 when the central banks of developed economies acted together to save the system with zero or negative interest rates and non-orthodox monetary tools such as Quantitative Easing. Although these tools are yet mostly theoretical, it’s testing and functioning is proving to be effective since then. In other words: printing money never sounded so smart.
Note from the author: Before we continue our analysis into the current situation, I need to point out a small intersection: every research on the field of social sciences must consider not only the primary effects, which are composed mainly by the visible phenomena but the secondary and tertiary effects of the observed objects. From now on, this article will flex on the application of Hegelian Dialectics -- “the art of thinking two things at the same time, as the philosopher Olavo de Carvalho use to say.
The “problem of printing money” is that the devaluation of currency does not affect all pairs the same way. Rich countries with accredited currencies like the Euro and the Dollar seems now to be able to use monetary tools without the restrictions Classic Monetary Theory teaches, like the trade-off between the money supply and inflation, for example. And while the money supply expands at the developed economies with apparently no restrictions, the interest levels are also diminishing at the Emerging Economies.
The disproportionate strength of the Euro and Dollar versus the Emerging’s Basket is causing a great devaluation of sovereign currencies worldwide. The increase in liquidity has the power to avoid a deeper economic recession in the short term but can enhance global income disparities at the pace the trading conditions become more and more unbalanced.
MSCI EM Currency Index. At: Investing.com
The great investor Ray Dalio has a vision about “paradigm shifts” under the argument that at every decade approximately, what’s worked in terms of monetary policies and investment in the last ten years won’t work anymore. The lack of coordinated monetary and fiscal policies to avoid bigger problems on the COVID19 crisis can create lower growth to everybody due to an already observed decrease in productivity and recent setbacks on globalization (see Donald Trump’s policies, for example), reflecting on lower profit margins to American companies.
The second graphic shows the effects of monetary expansion: The richest 10% are concentrating even more wealth while the last 90% is getting poorer. It’s the greatest disparity since the ’30s. The collaterals of this distortion are great social in-satisfaction, channelized in votes to populist governments.
The dollar is the reserve currency of the world. The United States has great power and privilege and they are abusing their status as they print money, creating an enormous déficit. The Africans have a proverb that translates what’s happening: “when elephants fight, it is the grass that suffers”. -- local money only has local purchase power and is subjected to local monetary measures, meaning that local money does not have the same power of the dollar.
Structurally, the increase of income disparity caused by lower growth (remember: smaller economies need to grow faster than large ones to cover the “income gap”) and expansionary monetary policies are creating an almost insurmountable obstacle to the Emerging Economies on trading and purchase power, culminating on economic stagnation, inflation, and impoverishment.
Not all problems are born humanitarian in the first place, some times they are born alongside a good-willed solution. The problems demonstrated above are a side effect of our parent’s dream: globalization. When the Emerging Economies were co-opted to jump onto the globalization boat at the end of the 20th Century, many decisions ceased to be made there, sovereignty was delegated. And as an extended thought, most of the Emerging countries don’t even have a sovereign currency.
By Ronaldo Teles
Ronaldo Teles is a 22 years old undergraduate student from Brazil. He studies Business Administration in the Universidade Federal de Pernambuco. During his work experience, he has been recognized by the Top 10 on Adecco CEO for One Month Brazil, Safra Top Gestor Award, Money Master Award, and winner Hacker a City Brazil (2017). His areas of interest include economy, administration, and philosophy.
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