Emerging economies on defense
The Federal Reserve announced last month an additional $10 billion tapering of the economic stimulus program that encouraged vast flows of investment money into emerging economies.
The tapering caused emerging market economies to suffer huge outflows of money, leading to currency depreciation and falling stock markets. The Dow, as those watching their 401(k)s will attest, has taken hits flirting with a correction.
Emerging countries' appeals to the Fed against the tapering were ignored. Many emerging nations raised interest rates, while others imposed exchange controls. If these fail to stem the outward flow of money, these nations may be tempted to introduce trade tariffs. Higher interest rates, exchange controls and trade tariffs could severely damage world trade, threatening international recession and the viability of “too-big-to-fail” banks.
In 2007, developed economies, fearing deep recession, reeled under the shock of widespread real estate speculation. The Fed-led international financial markets faced catastrophic collapse. Then-Fed Chairman Ben Bernanke's unprecedented recipe was stimulus bond-buying by the Treasury. For the moment, this appears to have saved Wall Street and emboldened investors and consumers to spend, even on credit.
Bernanke combined his stimulus with a Zero Interest Rate Policy, which forced savers to seek ever-greater risks to gain a reasonable return. The result of Bernanke's actions was to establish a pool of low-cost capital seeking higher-risk returns. Money flowed heavily to fast-growing but volatile emerging markets, driving up their asset prices, stock markets and currencies.
Sensing that sustained stimulus was damaging the economy, Bernanke announced in June the possibility of tapering the stimulus. Money started to leave emerging economies. In late 2013, Bernanke announced a $10 billion taper, causing a further fund flow from emerging economy markets and currencies.
By announcing a second $10 billion taper before his departure, Bernanke appeared to set a trend. Shocked emerging market governments initiated a wave of defensive interest rate hikes.
In so-called developed economies, where politicians talk in trillions, $10 billion appears as chump change. But it equals the combined average monthly portfolio investment into Brazil, Chile, Indonesia, India, Thailand, Turkey and Ukraine. At $20 billion, it would include Canada and Mexico.
A continued tapering trend would affect many nations, causing a huge exit of money. This would result in falling asset prices, stock markets and currencies, causing rising inflation and interest rates.
India's MIT-trained central bank governor, Raghuram Rajan, was among the first to predict the financial fiasco of 2007. Presciently, he raised Indian interest rates immediately on taking office in September. Late last month, Rajan said that in tapering the stimulus, the Fed was “attacking” emerging markets.
Creating $4 trillion by computer strokes and injecting it into the international economy was relatively easy. Unwinding it could cause international hardship and challenge.
John Browne, a former member of Britain's Parliament, is a financial and economics columnist for Trib Total Media. Contact him at firstname.lastname@example.org.