Emerging markets are in trouble…
The iShares MSCI Emerging Markets ETF (EEM), which holds roughly 800 emerging-market stocks, is down 23% since last September.
And things have gotten even worse recently. EEM has now fallen for the past seven days straight.
John Burbank thinks the strong U.S. dollar is a big reason why…
Burbank founded Passport Capital, a hedge fund that manages $4.1 billion. He made a fortune betting against the U.S. housing market in 2007. Passport Capital’s main fund returned 219% that year.
This year, Burbank’s Passport Global fund has gained 15%, while the S&P 500 has lost 3%. One reason Burbank has crushed the market this year is because he’s made big bets against emerging markets…
Emerging markets are countries that are on their way to becoming developed like the U.S. and Germany. China, Brazil, and Russia are all major emerging markets.
Burbank is bearish on emerging markets because companies in these countries have borrowed record amounts of U.S. dollars, as we recently explained. According to The Wall Street Journal, the amount of loans made in U.S. dollars to emerging-market borrowers has almost doubled since 2009.
• The strong U.S. dollar is making these loans a lot harder to pay off…
Regular Casey readers know the U.S. dollar has soared 13% versus other major currencies over the past year. And the dollar has gained far more against key emerging-market currencies…
The Russian ruble is down 41% against the U.S. dollar over the past year…the Brazilian real is down 36% against the dollar…and the Mexican peso is down 19%.
• The strong dollar is a big problem for foreign companies that borrowed U.S. dollars…
A stronger dollar makes it harder for foreign companies to pay back dollar-denominated debt. A Russian company that borrowed dollars, for example, now owes 41% more than it did last year. And even worse, its interest payments are 41% higher than last year.
Companies in emerging markets around the world are facing this problem. Bloomberg Business reports that there have already been more global corporate defaults this year than in all of 2014.
• Burbank worries the crisis in emerging markets will spread to the U.S.…
He explains in the Financial Times:
All of that turmoil around the world will come back and slow down capex and hiring and consumer buying in the US, and that will make the Fed realise they should be easing and not hiking.
Regular Casey readers know that the Fed’s go-to “easing” weapon is to lower interest rates. But the Fed can’t lower interest rates because interest rates are already near zero.
Burbank thinks the Fed will ease by launching another round of quantitative easing (QE).
• QE is just another term for money printing…
QE is when a central bank creates cash and injects it into the financial system.
The Fed launched QE1 in November 2008. It ran for 17 months and injected $1.4 trillion into the financial system.
QE1 didn’t jump-start the economy…so the Fed followed it up with two more rounds of QE, known as QE2 and QE3.
The Fed finally stopped its last round of QE in October 2014. By that point, it had pumped $3.5 trillion worth of cash into the financial system.
QE1, QE2, and QE3 did very little for the “main street” economy. But they goosed financial asset prices…
The S&P 500 gained 121% during the three rounds of QE. Since QE ended in October 2014, the S&P 500 has lost 3%.
• Burbank explained on CNBC’s Closing Bell show how QE fueled the borrowing binge in emerging markets:
QE enabled many companies and emerging market countries to get a lot of credit cheaply that they never should’ve gotten.
QE made money cheap. But now that QE has ended, dollars have become more expensive. Burbank continued on CNBC:
As the dollar rallies, as China slows, as the oil price crashes, all these things tighten credit conditions….All we’re seeing now is price validating and showing you the way things really are. I don’t see any reason why this is going to stop. I think you have to have imagination here though as to…[h]ow low emerging market stocks can go.
• The Fed has already injected $3.5 trillion in the U.S. financial system…
Burbank thinks it will have to inject even more cash into the financial system to stave off a crisis. He thinks the Fed will launch QE4.
We agree that the Fed will likely restart its easy money QE policies. The global economy is addicted to easy money like a junky is addicted to heroin. The crisis we’re seeing in emerging markets shows that cutting back on easy money policies, even just a little, can cause a global economic catastrophe.
• In today’s mailbag, James K. asks:
Who owns the Federal Reserve? And where does it get its funds from?
Dan Steinhart, executive editor of Casey Research, responds:
No one “owns” the Fed. But the U.S. government and Wall Street banks control the Fed.
Twelve people in the Fed hold most of the decision-making power. This group of 12 sets interest rates…decides how much money to print…and makes other important monetary decisions. It’s called the Federal Open Market Committee, or FOMC.
The Fed claims to be “independent” because the FOMC doesn’t answer to any branch of government.
But the Fed isn’t really independent…because the government and banks decide who gets on the FOMC in the first place. The president of the U.S. appoints seven of the 12 members. The other five members are chosen by politicians and banks.
Dan goes on to explain how the Fed creates money out of thin air:
As for part two of your question…the Fed creates money. It can create $500 billion by pressing a button.
This is why we recommend owning gold. Owning dollars is risky…because 12 powerful people in the Fed can decide to create $500 billion out of thin air. This dilutes the value of existing dollars and distorts the economy.
The Fed can’t create gold out of thin air. Gold will always be valuable, even if the Fed completely ruins the dollar.
We also recommend owning other investments that won’t lose their value during a dollar crisis. A dollar crisis could financially cripple you if you own just “conventional” assets like a bank account and stocks.
We explain all of our best advice on protecting your money from a dollar crisis in our new hardcover book. Right now, we’re giving this book away for just a small $4.95 processing fee. Click here to claim your copy.
Chart of the Day
All emerging markets are struggling…but Brazil is in a full-blown crisis.
Brazil is in its worst recession since the Great Depression, as we explained recently.
On Wednesday, Brazil’s currency, the real, hit an all-time low against the U.S. dollar. Brazilian stocks are also crashing…
Today’s chart shows the performance of the iShares MSCI Brazil Capped ETF (EWZ) over the past year. It’s down 61% since last September.
Delray Beach, Florida
September 25, 2015
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