The role reversal in emerging and mature markets

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My original intent with the Sovereign Vibe project was to write about emerging market sovereign debt and, also, about the resurgence of geopolitical and geoeconomic sovereignty.

This second category often falls under the umbrella term of “deglobalization” and is well-encapsulated by Trump tariffs, Brexit, Covid lockdowns, Russia’s invasion of Ukraine, and the resulting sanctions against Russia.

Although sovereign debt and deglobalization - or choose your preferred term, like the abhorrent neologism “slowbalization” pushed by the IMF’s Kristalina Georgieva - are closely-related, over time I have come to write more on the former category.

Yet it has been getting harder to keep that focus on emerging market sovereign debt, for several reasons.

Most importantly, the distinction between emerging and developed markets is disappearing.

“Developed” markets?

European anemia

There are longstanding problems in the Eurozone. As a case in point, rates in Greece, Italy, and elsewhere in the Eurozone periphery are artificially low, due to ECB bond-buying.

Even if France’s spread over the bund a few months ago was at Greek levels, it’s clear which country is the better credit, Paris budget profligacy and political instability notwithstanding.

Moreover, sovereign credits across Europe - and, yes, that includes Britain - will be under pressure from higher defense spending needs and undermined consumer confidence amid already-anemic growth.

U.S. idiocy

Worst of all is Trump’s aggrieved blundering on economic policy. While tariffs may be warranted against China’s artificially-low domestic consumption, such bilateral action is more likely to reconfigure supply chains to meet U.S. demand than to make a dent in the American trade deficit.

A multilateral “Tobin Tax” on international capital flows would be much more likely than trade barriers to redress global imbalances, i.e. the ~$1 trillion annual U.S. current account deficit and large surpluses in China and elsewhere.

In any case, U.S. tariffs against allied trading partners Canada, Mexico, and the European Union will hurt all parties, even without considering retaliatory measures.

Although it is debatable whether the U.S. economy would be stronger after a relative shift from services to manufacturing, a new industrial policy should concentrate on high value-added industries that are capital-intensive but not labor-intensive.

Hence the irony of Trump’s one-month tariff reprieve for car builders, as it is precisely a sector where the U.S. manufacturing could do well.

Trump’s policies have already sent U.S. markets into a tailspin as tariff-fueled inflation fears mount.

Similarly, the dollar has weakened amid markets anticipating the need for Fed support amid weakened demand, partially “DOGE”-inflicted.

All told, Trump-fueled policy uncertainty suggests that the emerging market shoe is on the other foot now.

Risks in emerging markets are almost stemming as much from policy volatility in Washington, D.C. as in these countries’ domestic situations.

It feels as though this could be the U.S.’s Brexit moment of self-inflicted pain, considering not only the reinvigorated trade wars but also the suspension of military aid to Ukraine, of USAID, and other related idiotic policies.

“Emerging” markets?

It used to be that the risks for emerging market investors were related to economic mismanagement: the lost decade in 1980s Latin America, the 1990s financial crises in Southeast Asia and Russia, Argentina’s spectacular series of defaults in the new millennium are emblematic of this.

To be sure the hard currency sovereign issuer universe has expanded greatly since the global financial crisis, which led some countries to over-borrow as over-eager investors searched for yield in the low-interest rate 2010s.

Along with excesses of China’s Belt-and-Road lending, this resulted in some defaults during the pandemic years of 2020-2022 (e.g. Zambia, Sri Lanka).

Yet a systemic emerging-frontier market debt crisis has been averted, so far, even if many countries are fiscally-strained under heavy public debt burdens.

This is because, for the most part, emerging markets have turned the corner in improving their economic governance.

Their central banks were quicker to respond to the inflationary threat in 2021-2022 than the Fed and other advanced economy central banks were, displaying a maturity that belies their “emerging” moniker.