The Crisis is Spreading

The crisis is now spreading to other economies (see this article), like Iceland, that relied heavily on borrowing at low interest rates to support their debt. Now repayment is very difficult.

Following the virtual seizing up of the Icelandic economy, countries such as Hungary, Argentina and Pakistan look vulnerable as they struggle to pay their bills. These countries took on large amounts of debt in the good times, when credit was cheap, and are now running out of money to pay them off because banks and investors refuse to lend to them.

This is the contagion. But while the crisis causes a recession in the US, the cost to emerging economies may be much greater.

Financial Crisis Impact on the Rest of the World

Our financial crisis is even causing concern in countries that have been rather critical of the US, especially in Latin America. See this article, for example, which notes:

Whipsawing global markets are already having a ripple effect across Latin America. As nervous investors pulled money out of emerging markets, Brazil’s currency, the real, plunged 16 percent against the dollar last month, resulting in hundreds of millions of dollars in losses at large food and eucalyptus-pulp exporters that placed bad bets on the direction of the real.

The crisis has had a big impact on Russia. The stock market has been closed on two separate days, an investment bank sold a large stake (50% minus 1 share) to an oligarch, and the government has been pumping money to support markets. The reason is that indebted banks have faced margin calls, especially as foreign investors flee to security in the worldwide crisis. What is important to remember is that Russia still has more than $570 billion in foreign reserves. This shows just how linked international markets are.

The Crisis Spreads to Emerging Markets

The financial crisis has spread to emerging markets:

Argentina’s bond markets were savaged on Tuesday as credit risk rose to all-time highs amid a broader surge in risk aversion towards emerging markets.

The move came as Russia’s stock market suffered its biggest one-day fall since the financial crisis of 1998, the South Korean won dropped by its most in a decade and the Ukrainian stock market fell 14 per cent.

Trading has been suspended on the Russian exchanges as shares nosedived:

Russian shares suffered their steepest one-day fall in more than a decade on Tuesday, losing up to 20 per cent, as a sharp slide in oil prices and difficult money market conditions triggered a rush to sell.

This is the biggest one-day dive since the August 1998 crash of the ruble. It is the combination of the credit crunch leading to margin calls and the fall in oil prices which (as we noted in a previous post) is the key fundamental driver of the Russian economy.