We now have a classic case of being careful about what you wish for.
When the Federal Reserve was ramping up its purchases of U.S. Treasury bonds to support the American economy, many overseas officials criticized the move, saying it put undue upward pressure on their currencies.
Brazilian Finance Minister Guido Mantega, for instance, suggested that the rich countries were engaged in a “currency war,” or a race to devalue, in order to gain a trade advantage and stimulate their economies.
The Fed’s purchase of bonds, starting in 2008, lowered our interest rates and devalued the dollar. But it also encouraged investors to put their capital into other countries, where higher rates were offered. The Fed’s ultra-easy monetary policies in fact encouraged an enormous flow of funds into developing nations, pushing up their currencies and stock markets.
But now the Fed is about do do what Brazil and other development countries wished: The Federal Reserve will cut back its bond buying from its current level of $85 billion a month. Sixty-five percent of economists in a Bloomberg Aug. 9-13 survey said the first cut would come at the Sept. 17-18 Federal Reserve Open Market Committee meeting.
As a result, investors are fleeing the currency, equity and bond markets of many emerging countries.
The risk of these pressures snowballing into a crisis that affects the world economy was emphasized at this year’s bankers’ summit at Jackson Hole, Wyo.
“There’s a lot of angst out there,” said Stanford University professor John Taylor, a former U.S. Treasury undersecretary. “There’s 35 central banks represented at this conference. Many of them are concerned about the impact of the exit on them.”
Also at Jackson Hole, Agustin Carstens, governor of Mexico’s central bank, argued that central banks in rich countries cannot change policies without recognizing the international effects of their actions. The alternative is to risk igniting another financial crisis.
As Adam Posen, president of the Peterson Institute for International Economics, a Washington, D.C., think tank, put it: “The more money pulls out, the worse these places look and the more people fear that they will not be able to get their money out.”
India’s rupee hit an all-time low versus the U.S. dollar on Aug. 26, and Indonesia’s rupiah fell to its lowest level in years. India’s slowest economic expansion (4.4 percent) since 2009 added pressure on Prime Minister Manmohan Singh to stem a slide in the rupee that forced the central bank to raise interest rates.
In South Africa, authorities want to halt the decline of the rand, which has fallen about 25 percent against the dollar in the past year. South African officials fear that raising interest rates would smother the country’s growth. Their economy is struggling to meet forecasts for 2 percent growth.
Despite the significant challenges facing the emerging markets, the Federal Reserve needs to remain focused on its mandate of pursuing policies that are in the best interests of the U.S. economy.
I worry about the long-term effect on the domestic economy of our central bank’s mammoth bond purchasing, which has expanded the Fed’s balance sheet from under $1 trillion in 2008 to $3.65 trillion today — an unsettling number. The Fed has been effectively printing money. Even with a reduction in bond-buying, the Fed’s balance sheet will continue to increase.
Stated differently, with our economy growing at 2.5 percent, we should not continue the same expansionary monetary policies that were appropriate when we faced an economic meltdown. Keeping our inflation rate under 2 percent and economic growth close to 3 percent are significant challenges best met with a razor-sharp focus on our domestic needs.
In the end, a strong American economy will be good for the rest of the world, too.
Originally published in the Sarasota Herald-Tribune
