Zero interest rates of US and low interest rates of other countries made cheap money to flow like water coming out of a fountain. The money flowed into the equities of emerging markets where in 2008 and beginning of 2009 all the emerging markets was valued at dirt cheap levels. This gave an opportunity to the cheap money to generate abnormal return from investing in emerging markets.
U.S. investors have pumped roughly $26 billion into emerging-markets funds so far this year. Of that, $15 billion came in through exchange-traded funds -- portfolios that hold every stock in a market benchmark with utterly no regard to price.
If we take the case of India we find that equity market recovered 90% from the lower levels of November 2008.
The same story is applicable for all the other BRIC nations’ stock market where a similar turnaround has happened. Several markets, such as Brazil and Peru, are up roughly 100% in 2009.These assets have suddenly soared to illogical growth resulted to another valuation bubble. We find that fundamentals don’t match with the assets price movement. In the past couple of months we failed to predict the BRIC nation’s equity markets and the reason behind such a failure is that cheap money flow.
The most fearful nightmare that is chasing the emerging market financial system is that once the US along with other nations hikes their interest rates the Cheap will no longer be available resulting pull back of the funds form the assets of emerging countries. This will result to a sudden cascading effect on the stock market. The gainers of this effect will be the cheap money and the losers will be those stock markets on whose cost the gains have been made.
Recently few of the economies have understood the cheap money theory and asset bubble which made them to change their policies to change the flow of cheap money.Brazil and China reacted to change the direction of cheap money.
WHY AND WHAT MADE TAIWAN TO LEASH THE EASY MONEY FLOW.
Ø Overseas funds bought $13.4 billion more Taiwan shares than they sold this year, helping lift the Taiex stock index 69% and the Taiwan dollar 1.7%.
Ø Brisk foreign fund inflows over the past month or so have pushed the Taiwan dollar to one-year highs this week.
Ø Improving relations with China and a pending agreement to expand cross-border investment is also attracting capital from abroad.
Ø Taiwan estimates $11 billion in speculative hot money that has flooded into the island will fall in the near future, as Asia central banks increasingly worry about brisk fund inflows into their local asset markets.
Ø The central bank bought the greenback to slow the local currency's gains on Nov. 17 after the island's dollar rose to the highest level in more than a month.
Stronger currencies could also crimp exports of emerging countries by making their goods less competitive, hindering economic recoveries.
Taiwan's exports fell for a 14th straight month in October, sliding 4.7% from a year earlier. So falling dollar have created a huge loss for the export countries and more gain for the players of cheap money
Brazil also followed a similar story which forced the economy to change the policies toward cheap money flow.
WHEN WE CAN EXPECT THE PULL BACK OF CHEAP MONEY.
Ø The US Federal Reserve’s insistence on near-zero interest rates has prompted investors to borrow cheaply in dollars to finance options on risky but high-yielding assets. That has created an enormous bubble.
Ø If the bubble goes off to burst out dollar will go simply go for reverse play.
Ø If the US economy enters a double-dip recession, or if it outperforms expectations prompting the Fed to raise interest rates sooner than anticipated, investors will close their short dollar positions and head for the safety of US Treasury bills, just as they did late last year.
Ø Even the World Bank last week warned that inflationary pressure could force central banks throughout Asia to tighten monetary policy, specifically citing equity and real estate prices in China, Singapore and Hong Kong as unsustainably high.
Now, with enormous reserves of liquidity chasing a small number of available assets, Asian central bankers are faced with a choice:
Ø allow their currencies to appreciate at the expense of exporters,
Ø Intervene regularly in foreign exchange markets to keep currency rates as they are.
So in the coming days we will find many economies to change their policies to reduce the flow of cheap money into their markets.
A similar planning is happening at India too but it will not go for such a decision at present to curb the flow of cheap money. It will wait for much longer time to see the actions of other economies on cheap money.
So India will have some time still left to enjoy the cheap money. But when interest rates will increase in the coming days by other economies, just imagine Indian market at that point of time. Assets will make a cascading journey, ruining the retail investor’s hard earned money by a sudden shock.
Taiwan and Brazil changed their policies to curb cheap money in order not to get their retail investors hard earned money ruined by a sudden shock.
In my next article I will bring forward the Indian story of cheap money.