Argentina shows the bad side of quantitative easing

This past week, there has been a frenzy of selling of emerging markets assets. The outflows from both stocks and debt in emerging markets reached their highest level since December 2016.

This amounted to $3.7 billion withdrawn from emerging market equities and bonds, according to data analysed by Bank of America Merrill Lynch. These outflows have helped push our old friend, the Bull/Bear indicator developed by BofA Merrill Lynch, to 4.8 — its lowest level since January 2017.

Far from being a bad thing, this withdrawal of hot money from emerging markets is in fact healthy. It will teach people a lesson that many had forgotten: being an emerging market investor is for the long haul. And it will teach emerging market policymakers that policies need to be sustainable to attract investment.

As US Treasury yields hit the psychologically significant 3% level, it has dawned on many fair weather investors that cheap money isn’t that cheap anymore. And they’re beginning to reassess the choices they made previously, when they were throwing money at developing countries with their eyes closed.

Argentina is of course the most obvious example. Judging by its present situation, the one-year anniversary of that country’s launch of a 100-year bond on June 20 is going to be very low key. The offer was three and a half times oversubscribed at the launch in June last year; and that was just one year after the country had emerged from default!

Currently, that bond trades at around 85% to par, as Argentina has surprised the markets by issuing a plea of help to the International Monetary Fund (IMF) after a series of interest rate hikes in an attempt to stop its currency from sinking.

A look at Argentina’s macroeconomic data reveals a troubling picture: the budget deficit is around 7% of gross domestic product; interest rates are around 40% and expected to stay there until at least the end of the year; the current account deficit is somewhere around 5%.

But such imbalances do not arise overnight. They have built up in the years when populists mistook the international wave of liquidity that supported all emerging markets for a vote of confidence in their own policies.

Or rather, more cynically, the former Argentine government took advantage of the money created by developed world central banks to apply policies that brought short-term gain for politicians but are causing long-term pain for the population.

Argentina’s example is only the most egregious, but it embodies what has happened in a lot of countries, developing and developed ones, during the years of quantitative easing: a surge in populism causing bad economic policies that endanger economic sustainability over the long term.

The other side of the equation doesn’t look prettier either: years of cash abundance have blinded investors to policy mistakes and unsavoury local features such as corruption, the rule of law and human rights.

They poured money into places like Russia, China, Hungary, Turkey – all vying for the dubious title  of dictatorship-disguised-as-democracy – with their eyes closed, in search of a couple of percentage points more in yield.

The violent outflows for emerging markets are signalling that the days of plenty are over. Hopefully, this will be a wake-up call for politicians, investors and, most importantly, central bankers. Nothing is without bad consequences, as well as good; not even quantitative easing.

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