Janet Yellen probably doesn't think about Bangkok, Jakarta or Manila very often -- the Federal Reserve chair has enough to worry about in Washington. But as she continues to ponder hiking interest rates, the frenetic selloffs in stock markets on the other side of the world should give her pause.
Stock exchanges in emerging markets are on their longest losing streak since 1990; since a late-April high, the MSCI Southeast Asia Index has lost almost 9 percent. If Yellen is wondering whether the developing world is ready for a tightening of U.S. monetary policy, the answer from Asia has been a resounding no.
Late last year, a tightening of 25 basis-points would probably not have posed any problems. But, in the interim, China's slowdown has darkened the global economic outlook (even as its own equity bourses continue to skyrocket). Selloffs in Indonesia, Malaysia, the Philippines, Thailand and elsewhere speak to the growing anxiety about the two biggest actors in the global economy.
The most immediate worry is the trade shock emanating from China. Massive share rallies in Shanghai and Shenzhen are papering over a growing number of economic cracks in China, including deflation and weak household spending. Despite government pledges to achieve 7 percent growth, sliding commodity prices suggests Chinese growth is decelerating. And MSCI's decision not to include China in its indices is a reminder that Asia has been hitching its future on an economy that isn't yet ready for prime time.
Asia also worries that China's problems will be exacerbated by the Fed. Monetary purists will be tempted to dismiss the argument out of hand -- the Fed should focus on keeping the U.S. economy stable and healthy, because that's ultimately in the best interests of everyone from Seoul to Sao Paulo.
What this line of thinking misses, though, are the feedback effects created by Fed policy. As the dollar rises, it draws money away from the developing world -- often violently so. Consider how a strong dollar helped precipitate Asia's 1997-1998 crisis and Latin America's a decade earlier.
The world, it must be acknowledged, has become addicted to zero interest rates. In the 10 years between its late-1990s crisis and Wall Street's in 2008, countries in Asia stabilized their banking systems, diversified their economies away from exports, encouraged entrepreneurship and attacked corruption. Central banks in the region amassed trillion of dollars of currency reserves and markets became more transparent. But the urgency disappeared as ultralow rates in Washington, Tokyo, Frankfurt and London sent waves of liquidity Asia's way, boosting equities, lowering bond yields and ginning up growth.
Quantitative easing arguably benefited Asia more than the West. Officials in the region have spent the past several years signing foreign-direct-investment deals -- witness the many splashy new skyscrapers, shopping malls, and state-of-the-art factories funded by foreign money -- and celebrating countless initial public offerings on their stock exchanges. Complacency set in as unproductive investments accumulated, cronyism thrived and everything from financial systems to education programs went neglected.
Asian markets are understandably anxious about the prospect of the monetary fuel that's been driving this growth these last six or seven years running dry. Reclaiming monetary normalcy can be a near-impossible task once investors, bankers, businesspeople and politicians alike get used to wonders of free money. That's especially true of nations with sizeable debt loads. (Yes, that means America and Europe.)
Central bankers also find it hard to withdraw from loose money policies. They know that at the first sign of financial fallout, lawmakers will be quick to blame them for acting too rashly. The Fed now finds itself at the same crossroads at which the Bank of Japan stood nine years ago. In February 2006, the BOJ began raising rates away from zero -- 25 basis points and another 25 in February 2007. The Japanese establishment howled its disapproval as deflation deepened and the BOJ was back at zero by 2009. The massive QE-programs initiated by current BOJ head Haruhiko Kuroda suggest Japan will be at zero many years to come.
Understandably, Yellen doesn't want to get trapped in Japan's dysfunctional cycle. But when you're in charge of the Fed, you're responisible for more than just the U.S. economy. And it increasingly seems that the rest of the world, and Southeast Asia in particular, isn't prepared for the sort of shock that Yellen seems to have in store.
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