It sounds like the beginning of a hopelessly corny joke: what do Madonna and emerging financial markets have in common? The answer is no joke at all.
Both the rock star and the markets have clearly demonstrated the value of reinventing and repackaging themselves for enormous material gain. Madonna transformed herself from a suburban Boy Toy into a quasi-feminist multimillionaire. Emerging markets, recently the darlings of international finance, underwent an equally dramatic transformation. And both have fallen out of favor—at least in part—because of relentless hype and overexposure.
Emerging markets were not always chic. In 1982, the year that Mexico defaulted on $65 billion in loans and touched off a global banking crisis, they went by the distinctly unglamorous acronym, LDCs; they represented the debt from a hodgepodge of Lesser Developed Countries in Latin America, Asia and Africa. But after some strategic cosmetic surgery LDCs hanged into “emerging markets,” a term that evokes a brisk new image of bustling economic activity and prosperity.
Much of the beauty in that makeover, however, lies in the wishful eyes of the beholders: international investors eager to latch on to the latest trend. As investors crawled from the wreckage of the recession into an era of tepid growth in mature economies, their heads were easily turned by the dazzling prospect of 13.4-per-cent annual growth in China, 9.8 per cent in Singapore and 7.5 per cent in Thailand. Trading in the debt of such emerging markets quickly advanced from a sideshow into a main event, the volume soaring from $105 million in 1990 to about $2 trillion in 1993. Stock markets in such high-octane countries also surged ahead, fuelled by lusty appetites for rich returns.
In their rush of enthusiasm, the stewards of billions of dollars in pension fund and mutual fund money began to forget that risk and reward, as tea and sympathy, go together. As the momentum gathered, a range of gleaming new
financial products suddenly appeared like mushrooms on a damp lawn, to empower individual investors to tap into the boom. In the 1990s, a new day was dawning in Asia and Latin America, money managers crowed, and the financial world was expanding from a narrow band of seven key currencies and interest rates. An Emerging Market Traders Association was formed.
Then reality bit—hard. With one jot of a well-sharpened pencil, the Federal Reserve in Washington proved once again that there are, in fact, only three currencies that count—the U.S. dollar, the yen and the German mark. On Feb. 4, intent on containing economic growth and trampling any signs of inflation, the Fed nudged U.S. interest rates higher for the first time in five years. Although the increase was a scant 0.25 per cent, it was enough to send heady bond markets into a tailspin and to puncture the euphoric emerging markets bubble.
The recent meltdown in emerging markets was the best thing for them
That correction— and the chance for everyone involved to take a deep breath— was probably the best thing that could possibly have happened. There is no question that over the longterm, emerging markets offer strong potential gains. But the real risk is that impatient international investors, backed by billions of dollars in restless pension and mutual fund money, will distort and damage new markets by over-capitalizing them before they are able to handle it. To successfully rebound from the abrupt backlash that frequently follows sudden infatuation, emerging markets need an element of stability and structure that they have not yet had the time or the experience to develop.
Accustomed to playing by their own rules in a fast field of relative equals, big investors have to learn to invest responsibly and not to impose unrealistic expectations on those still struggling to find their feet. In many of these economies, debt and equity markets are relatively new and offer limited liquidity and market capitalization. It is easy and dangerous to overwhelm them. And unlike the rich, they do not yet have the option of graceful retreat.
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