Are the US and other developed countries responsible for the emerging market issues? Or in the alternative, are the all the emerging market troubles home grown? It will be interesting to see who the developed countries blame when the problems they created for emerging markets return home
There is going to be trouble down under. Australia is hosting the latest G-20 meeting. Finance ministers from most G20 countries will travel to Sydney. Christine Lagarde, the IMF’s managing director will be there as will the new chairwoman the Federal Reserve (Fed), Janet Yellen. The meeting might be a bit more contentious than most. The recent turmoil in emerging markets (EMs) has many pointing fingers at the Fed as the cause of their problems.
One of the most articulate is Raghuram Rajan, the governor of the Reserve Bank of India (RBI). Last month he accused the developed countries (DMs) of ignoring the issues of the EMs. He said, “Industrial countries have to play a part in restoring that [co-operation], and they can’t at this point wash their hands off and say, we’ll do what we need to and you do the adjustment.” He accused the DMs of ingratitude. “Emerging markets tried to support global growth by huge fiscal and monetary stimulus”. He was upset that developed countries, particularly the US, were insensitive to the problems created by the end of their stimulus programs specifically the quantitative easing (QE) program in the US.
Janet Yellen confirmed his view. She is focused on the US economy and that is it. She said, “Our sense is that at this stage these developments do not pose a substantial risk to the US economic outlook”. So as long as an EM melt down does not affect the US, it is their problem. Mr. Rajan thought that this view was too narrow. He warned that the DMs including the US “may not like the kinds of adjustments we will be forced to do down the line”.
Who is right? Are the US and other developed countries responsible for the emerging market issues? Or in the alternative are the all the emerging market troubles home grown?
One view is that since 2008, the central banks of the US, Europe and now Japan were irresponsibly flooding the world’s markets with cheap money. This led to an artificial devaluation of the dollar and recently the yen. Printing money to debase your currency may help exports, the cause of the Japanese market rally. But it also unleashes a flood of money into emerging markets as investors search for yield. This produced a credit boom. The boom created deficits and is turning into a bust. The deficits have lead to lower exchange rates, inflation, higher interest rates and inevitably slower growth.
There is another view. It is that the developed countries’ stimulus packages were valid attempts to stimulate their economies. Any spill over into emerging markets should have been dealt with by a change of government policies. India’s problem stems from a misguided agricultural policy that drives up food prices and increases inflation. The government has not been able to reform these subsidies, cut the budget deficit or reform the labour market. Turkey’s recent battering has been due to political turmoil and risk of flight capital.
I find any finger pointing at emerging economies failure to reform as enormously hypocritical. The developed countries have not been able to make substantive changed in their policies. Neither the EU nor Japan has had any luck in reforming their labour policies. Japan has one of the most bizarre agricultural regimes anywhere while the US just passed a trillion dollar farm bill with large subsidies.
In fact, the reason why central bankers in developed countries stepped in with their massive money printing stimulus programs was that their governments could not agree on a comprehensive program of fiscal stimulus and policy reform. Rather than limit themselves to what they are reasonably good at, delivering low inflation and some level of financial stability, central bankers embarked on huge experimental programs with unknown and unintended collateral consequences.
I would put all of the blame on arrogant and short sighted DM central bankers with one caveat. Almost a trillion dollars from developed countries flowed into emerging markets between 2007 and 2012. But this number is dwarfed by the $3 trillion rise in assets under management (AUM) by EM governments. Sovereign Wealth Funds and developing country central bankers have over $11 trillion under management and much of that is invested in developed countries. Since a great deal of these funds are no doubt invested in US treasuries, the EM countries themselves made it much easier for the US to employ its money stimulating policies.
Governor Rajan is definitely right in his pleas for cooperation. One of the reasons for the Great Recession, in my view, was that Alan Greenspan ignored the effect on US interest rates of China. China by buying large amounts of US treasuries to artificially keep its currency low also helped moderate US interest rates. Greenspan attributed it to his own abilities. The result was a disaster.
It appears that Ben Bernanke and now Janet Yellen are making the same mistake. Ignoring the risk to emerging markets from the beginning of QE was a major mistake. Japan’s central banker Kuroda is only increasing the problems. It all might have been worth it if these programs actually worked, but they haven’t. Growth in the US and Japan remains lacklustre and neither government has had any success in streamlining their policies to create an environment necessary for real and sustainable growth.
Governor Rajan is also correct that central bankers may not like what is coming down the line. John Dunne’s famous observation that no man is an island applies to global economics as well. It will be interesting to see who the developed countries blame when the problems they created for emerging markets return home.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)