Emerging Markets Should Quit Their Whining
Emerging markets have been among the biggest victims of bets that the U.S. Federal Reserve is getting ready to take away the monetary punch bowl. This has led to a lot of whining from people who ought to know better. Central bankers in the U.S. and elsewhere shouldn't worry about the effects of their policies outside their borders.
Let's start with some context. The Indonesian stock market has lost nearly a quarter of its value since the end of May. The Brazilian real is now more than 26 percent cheaper relative to the dollar than it was back in 2010, when Guido Mantega, Brazil's finance minister, warned that loose U.S. monetary policy would start a global "currency war." (I guess Brazil won!) Panama's 40-year bond, which was issued at the end of April, is now trading around 75 cents on the dollar.
None of those facts should affect decisions by U.S. central bankers. For one thing, large capital flows into and out of emerging markets are neither new nor rare. In the 1970s, Middle Eastern oil kingpins recycled their newfound wealth into Latin American debt through American and European banks. Those huge inflows promptly reversed once monetary policy tightened across the rich world, saddling many poorer countries with lost decades of almost zero growth. Then, in the early 1990s, low rates in the rich world following a banking crisis encouraged speculative investments in Southeast Asia, Turkey and Latin America. (Sound familiar?)
Michael Pettis's "The Volatility Machine" explains why this keeps happening. For one thing, rich countries have a lot more wealth to move around than poor ones. Relatively small portfolio shifts among savers in the U.S., Europe and Japan can have very large effects on the financial systems of poorer countries. But that's an insufficient explanation, since emerging-market policymakers have lots of tools at their disposal to limit the damage caused by excessive capital inflows. (Some of those measures were discussed at the recent monetary policy conference in Jackson, Wyoming.)
According to Pettis, the real problem is that most emerging countries fail to use these tools, or worse, deliberately create "procyclical" balance sheets. In the 1970s and 1990s, they borrowed short-term in the currencies of the rich countries because it made debt service cheap while the "hot money" kept rolling in. For the most part, this particular mistake hasn't been repeated, which is why no country has yet suffered an acute crisis. However, most countries -- with a few notable exceptions including Korea -- failed to take the necessary precautions to truly protect themselves.
The other reason for U.S. policymakers to ignore what happens in emerging markets is that they did the same thing to us. These countries spent many trillions of dollars accumulating foreign exchange reserves during the 2000s. While I'm not persuaded by those who argue that this was the main cause of the U.S. housing bubble, it's hard to deny that those flows had a significant impact on America's trade balance, manufacturing employment, and federal budget deficit. Emerging markets accumulated their reserves for their own domestic reasons without significant consideration for the wellbeing of Americans. What's good for the goose is good for the gander.
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Matthew C Klein