Feb 11th 2014

Death by Finance

PRINCETON – How quickly emerging markets’ fortunes have turned. Not long ago, they were touted as the salvation of the world economy – the dynamic engines of growth that would take over as the economies of the United States and Europe sputtered. Economists at Citigroup, McKinsey, PricewaterhouseCoopers, and elsewhere were predicting an era of broad and sustained growth from Asia to Africa.

But now the emerging-market blues are back. The beating that these countries’ currencies have taken as the US Federal Reserve begins to tighten monetary policy is just the start; everywhere one looks, it seems, there are deep-seated problems.

Argentina and Venezuela have run out of heterodox policy tricks. Brazil and India need new growth models. Turkey and Thailand are mired in political crises that reflect long-simmering domestic conflicts. In Africa, concern is mounting about the lack of structural change and industrialization. And the main question concerning China is whether its economic slowdown will take the form of a soft or hard landing.

This is not the first time that developing countries have been hit hard by abrupt mood swings in global financial markets. The surprise is that we are surprised. Economists, in particular, should have learned a few fundamental lessons long ago.

First, emerging-market hype is just that. Economic miracles rarely occur, and for good reason. Governments that can intervene massively to restructure and diversify the economy, while preventing the state from becoming a mechanism of corruption and rent-seeking, are the exception. China and (in their heyday) South Korea, Taiwan, Japan, and a few others had such governments; but the rapid industrialization that they engineered has eluded most of Latin America, the Middle East, Africa, and South Asia.

Instead, emerging markets’ growth over the last two decades was based on a fortuitous (and temporary) set of external circumstances: high commodity prices, low interest rates, and seemingly endless buckets of foreign finance. Improved macroeconomic policy and overall governance helped, too, but these are growth enablers, not growth triggers.

Second, financial globalization has been greatly oversold. Openness to capital flows was supposed to boost domestic investment and reduce macroeconomic volatility. Instead, it has accomplished pretty much the opposite.

We have long known that portfolio and short-term inflows fuel consumption booms and real-estate bubbles, with disastrous consequences when market sentiment inevitably sours and finance dries up. Governments that enjoyed the rollercoaster ride on the way up should not have been surprised by the plunge that inevitably follows.

Third, floating exchange rates are flawed shock absorbers. In theory, market-determined currency values are supposed to isolate the domestic economy from the vagaries of international finance, rising when money floods in and falling when the flows are reversed. In reality, few economies can bear the requisite currency alignments without pain.

Sharp currency revaluations wreak havoc on a country’s international competitiveness. And rapid depreciations are a central bank’s nightmare, given the inflationary consequences. Floating exchange rates may moderate the adjustment difficulties, but they do not eliminate them.

Fourth, faith in global economic-policy coordination is misplaced. America’s fiscal and monetary policies, for example, will always be driven by domestic considerations first (if not second and third as well). And European countries can barely look after their own common interests, let alone the world’s. It is naïve for emerging-market governments to expect major financial centers to adjust their policies in response to economic conditions elsewhere.

For the most part, that is not a bad thing. The Fed’s huge monthly purchases of long-term assets – so-called quantitative easing – have benefited the world as a whole by propping up demand and economic activity in the US. Without QE, which the Fed is now gradually tapering, world trade would have taken a much bigger hit. Similarly, the rest of the world will benefit when Europeans are able to get their policies right and boost their economies.

The rest is in the hands of officials in the developing world. They must resist the temptation to binge on foreign finance when it is cheap and plentiful. In the midst of a foreign-capital bonanza, stagnant levels of private investment in tradable goods are a particularly powerful danger signal that no amount of government mythmaking should be allowed to override. Officials face a simple choice: maintain strong prudential controls on capital flows, or be prepared to invest a large share of resources in self-insurance by accumulating large foreign reserves.

The deeper problem lies with the excessive financialization of the global economy that has occurred since the 1990’s. The policy dilemmas that have resulted – rising inequality, greater volatility, reduced room to manage the real economy – will continue to preoccupy policymakers in the decades ahead.

It is true, but unhelpful, to say that governments have only themselves to blame for having recklessly rushed into this wild ride. It is now time to think about how the world can create a saner balance between finance and the real economy.


Copyright: Project Syndicate, 2014.
www.project-syndicate.org

 


This article is brought to you by Project Syndicate that is a not for profit organization.

Project Syndicate brings original, engaging, and thought-provoking commentaries by esteemed leaders and thinkers from around the world to readers everywhere. By offering incisive perspectives on our changing world from those who are shaping its economics, politics, science, and culture, Project Syndicate has created an unrivalled venue for informed public debate. Please see: www.project-syndicate.org.

Should you want to support Project Syndicate you can do it by using the PayPal icon below. Your donation is paid to Project Syndicate in full after PayPal has deducted its transaction fee. Facts & Arts neither receives information about your donation nor a commission.

 

 

Browse articles by author

More Current Affairs

Apr 16th 2021
EXTRACT: "When we examined the development of nations worldwide since 1820, we found that among rich Western countries like the United States, the Netherlands and France, improvements in income, education, safety and health tracked or even outpaced rising gross domestic product for over a century. But in the 1950s, even as economic growth accelerated after World War II, well-being in these countries lagged.
Apr 11th 2021
EXTRACT: "Some presidents indulge in the “Mount Rushmore syndrome” making an obvious effort to achieve greatness. Normally soft-spoken and apparently modest Biden is making his own bid for immortality."
Apr 9th 2021
EXTRACT: "New ways of thinking about the role of government are as important as new priorities. Many commentators have framed Biden’s infrastructure plan as a return to big government. But the package is spread over eight years, will raise public spending by only one percentage point of GDP, and is projected to pay for itself eventually. A boost in public investment in infrastructure, the green transition, and job creation is long overdue."
Apr 7th 2021
EXTRACT: " One can, and perhaps should, take the optimistic view that moral panics in the US blow over; reason will once again prevail. It could be that the Biden era will take the sting out of Trumpism, and the tolerance for which American intellectual life has often been admired will be reinvigorated. This might even happen while the noxious effects of American influence still rage in other countries. For the sake of America and the world, one can only hope it happens soon.  "
Mar 28th 2021
EXTRACT: "By refusing (despite having some good reasons) to end electoral gerrymandering, Chief Justice John G. Roberts, Jr., has directly enabled the paralyzing hyper-partisanship that reached its nadir during Donald Trump’s presidency. By striking down all limits on corporate spending on political campaigns in the infamous 2010 Citizens United decision, he has helped to entrench dark money in US politics. And by gutting the 1965 Voting Rights Act in Shelby County v. Holder, Roberts has facilitated the racist voter-suppression tactics now being pursued in many Republican-controlled states."
Mar 24th 2021
EXTRACT: "the UK’s tough choices accumulate, and the problems lurking around the corner look menacing. Britain will have to make the best of Brexit. But it will be a long, hard struggle, all the more so with an evasive fabulist in charge."
Mar 15th 2021
EXTRACT: "Over the years, the approach of most American policymakers toward the Israeli-Palestinian conflict has been Israel-centric with near total disregard for the suffering endured by the Palestinian people. The architects of policy in successive US administrations have discussed the conflict as if the fate of only one party (Israel) really mattered. Israelis were treated as full human beings with hopes and fears, while Palestinians were reduced to a problem that needed to be solved so that Israelis could live in peace and security.  ..... It is not just that Israelis and Palestinians haven’t been viewed with an equal measure of concern. It’s worse than that. It appears that Palestinians were judged as less ​human than Israelis, and were, therefore, not entitled to make demands to have their rights recognized and protected."
Mar 8th 2021
EXTRACTS: "XThere’s a global shortage in semiconductors, and it’s becoming increasingly serious." ...... "The automotive sector has been worst affected by the drought, in an era where microchips now form the backbone of most cars. Ford is predicting a 20% slump in production and Tesla shut down its model 3 assembly line for two weeks. In the UK, Honda was forced to temporarily shut its plant as well." ..... " As much as 70% of the world’s semiconductors are manufactured by just two companies, Taiwan Semiconductor (TSMC) and Samsung."
Mar 5th 2021
EXTRACT: "Back in 1992, Lawrence H. Summers, then the chief economist at the World Bank, and I warned that pushing the US Federal Reserve’s annual inflation target down from 4% to 2% risked causing big problems. Not only was the 4% target not producing any discontent, but a 2% target would increase the risk of the Fed’s interest-rate policy hitting the zero lower bound. Our objections went unheeded. Fed Chair Alan Greenspan reduced the inflation target to 2%, and we have been paying for it ever since. I have long thought that many of our economic problems would go away if we could rejigger asset markets in such a way as to make a 5% federal funds rate consistent with full employment in the late stage of a business cycle."
Mar 2nd 2021
EXTRACT: "Under these conditions, the Fed is probably worried that markets will instantly crash if it takes away the punch bowl. And with the increase in public and private debt preventing the eventual monetary normalization, the likelihood of stagflation in the medium term – and a hard landing for asset markets and economies – continues to increase."
Mar 1st 2021
EXTRACT: "Massive fiscal and monetary stimulus programs in the United States and other advanced economies are fueling a raging debate about whether higher inflation could be just around the corner. Ten-year US Treasury yields and mortgage rates are already climbing in anticipation that the US Federal Reserve – the de facto global central bank – will be forced to hike rates, potentially bursting asset-price bubbles around the world. But while markets are probably overstating short-term inflation risks for 2021, they do not yet fully appreciate the longer-term dangers."
Feb 28th 2021
EXTRACT: "To be sure, calls to “build back better” from the pandemic imply some awareness of the need for systemic change. But the transformation we need extends beyond constructing modern infrastructure or unlocking private investment in any one country. We need to re-orient – indeed, re-invent – global politics, so that countries can cooperate far more effectively in creating a better world."
Feb 23rd 2021
EXTRACT: "So, notwithstanding the predictable release of pent-up demand for consumer durables, face-to-face services show clear evidence – in terms of both consumer demand and employment – of permanent scarring. Consequently, with the snapback of pent-up demand for durables nearing its point of exhaustion, the recovery of the post-pandemic US economy is likely to fall well short of vaccine development’s “warp speed.” "
Feb 20th 2021
EXTRACT: "Human rights abuses under Erdogan are beyond the pale of inhumanity and moral decadence. The list of Erdogan’s violations and cruelty is too long to numerate. The detention and horrifying torture of thousands of innocent people for months and at times for years, without being charged, is hard to fathom. Many prisoners are left languishing in dark cells, often in solitary confinement. The detention of tens of thousands of men and hundreds of women, many with their children, especially following the 2016 failed coup, has become common. It is calculated to inflict horrendous pain and suffering to bring the prisoners to the breaking point, so that they confess to crimes they have never committed."
Feb 20th 2021
Courtyard of the Amsterdam Stock Exchange, circa 1670, (Job Adriaenszoon Berckheyde).
Feb 12th 2021
EXTRACT: "Global regulators will no doubt be concerned about a potential volatility spillover from digital asset prices into traditional capital markets. They may not permit what could quickly amount to effective proxy approval by the back door for companies holding large proportions of a volatile asset on their balance sheets."
Feb 11th 2021
EXTRACT: "Since Russians began protesting opposition leader Alexei Navalny’s imprisonment, the security forces have apparently had carte blanche to arrest demonstrators – and they have done so by the thousands. If Russians so much as honk their car horns in solidarity with the protesters, they risk personal repercussions. The official response to the protests goes beyond the Kremlin’s past repression. It is war."
Feb 6th 2021
EXTRACT: ".......like Biden, Roosevelt was certainly no revolutionary. His task was to save American capitalism. He was a repairer, a fixer. The New Deal was achieved not because of Roosevelt’s genius or heroism, but because enough people trusted him to act in good faith. That is precisely what people are expecting from Biden, too. He must save US democracy from the ravages of a political crisis. To do so, he must reestablish trust in the system. He has promised to make his country less polarized, and to restore civility and truth to political discourse. In this endeavor, his lack of charisma may turn out to be his greatest strength. For all that he lacks in grandeur, he makes up for by exuding an air of decency."
Feb 2nd 2021
EXTRACT: "Europe must not lose sight of the long game, which inevitably will center on China, not Russia or relations with post-Brexit Britain. China is already establishing a presence in Iran, and demonstrating that it has the capital, know-how, and technology to project power and influence beyond its borders. Should it succeed in turning the Belt and Road Initiative into a line of geopolitical stepping-stones, it might soon emerge at Europe’s southeastern border in a form that no one in the EU foresaw."
Jan 29th 2021
EXTRACT: "One sign of this change is that, unlike all recent Democratic administrations, Biden’s hasn’t paid obeisance to Wall Street by giving bankers top jobs. The new Secretary of the Treasury, Janet Yellen, is a former Federal Reserve chair and academic who has made it clear that she understands the country’s pressing social needs. Moreover, Biden consulted Warren on her economic views, and has named a former Warren adviser as Yellen’s deputy. Yellen’s appointment demonstrates that Biden shares the insight that enabled Trump’s rise: that too many Americans feel that they cannot get a fair share. "