By Anthony Harrington
There is not a smidgen of doubt in the minds of many economists and market watchers that the crisis that swept through Emerging Markets (EM) from around May, ending for now with the U.S. Federal Reserve chairman Ben Bernanke’s press conference 18 September 18, can be laid squarely at Bernanke’s door. On past form, the US doesn't particularly care if various bits and pieces of the global economy get squished as it rolls over in bed or stretches its limbs. Its key officials are accustomed to doing what they think is best for Uncle Sam and then arguing that, ultimately, what is good for the U.S. economy is good for the world - why worry about a little squealing here and there?
However, this last crisis was enough to give most market watchers pause, particularly since it is very likely to reoccur just as soon as the Fed re-initiates talk about tapering off its quantitative easing (QE) program. Emerging markets now account for some 50% of the world's economy, not 15% as was the case when the U.S. triggered the Asian Tiger crisis. Emerging market growth is probably the only thing that is remotely likely to pull advanced economies out of their long slump - and knocking over the economies of countries like India, Indonesia and the Philippines is going to hurt the West and America, like it or not. Unfortunately, the U.S. in general, and Ben Bernanke in particular, do not appear to have taken this particular point. The senior economists at Scotiabank, for example, argue that it is very unlikely that the Fed will hold off from implementing tapering at some point.
In an article for Financial Post, John Shmuel quotes Scotiabank economists Derek Holt and Dov Zigler as arguing that putting off tapering would simply postpone a much needed re-balancing of global capital flows, and implement much more rigorous fiscal disciplines in the countries most affected. In other words, tough luck India, Philippines, Indonesia and the rest - don't worry about your stock markets crashing as foreign currency gets expatriated back to dollar assets, this medicine is good for you too.
But let us take a step back and look at some facts around this crisis and how U.S. monetary policy initiatives in the past have impacted upon Asian economies in particular. The obvious case in point is the Asian crisis of 1997. As Galina Hale of the San Francisco Federal Reserve notes in her paper, Could we have learned from the Asian financial crisis of 1997-98?, prior to the crisis, most East Asian countries had currencies pegged to the U.S. dollar and ran current account deficits. Companies in East Asia borrowed heavily in dollars from foreign banks and (for the most part) earned revenues in local currencies, creating a mismatch where their liabilities were largely in dollars, while their assets were in local currencies. On July 2, 1997, speculators went after the Thai bhat big time, selling off bhat denominated assets while other foreign investors, seeing what was happening, pulled their U.S. dollar loans to Thai institutions.
The bhat dropped 16% on the day, and by January 1998 had lost over 50% of its value. Currency after currency came under attack and government after government was forced to abandon the dollar peg and let their currencies plunge. Those mismatched assets and liabilities caused company after company to fold. Thai and other East Asian banks who had been accustomed to borrowing short term on the money markets found liquidity drying up. Governments had to step in to bail out their banks and then go cap in hand to the International Monetary Fund [IMF]. This was the era of Alan Greenspan as chairman of the Fed. In the summer of 1998, with the Asian crisis in full swing, Greenspan stood up at the Fed's semi-annual testimony in late June and said he was more concerned about domestic inflationary pressures than he was about the emerging market crisis. This was widely interpreted as a sign that the U.S. was likely to raise rates to squeeze out inflation, which would massively aggravate the already dire position for Asian markets, and the crisis worsened sharply. The Russian crisis then kicked in and by the end of August 1998, at the Fed's Jackson Hole meeting, Greenspan had to go into reverse and shift to more accommodating policies. Bernanke has now run into similar problems with a similar U-turn.
It is worth noting that Fed chairmen and U.S. politicians generally win very few plaudits at home for stopping emerging markets from nose diving. So, it is quite possible that Bernanke's U-turn, after talking up tapering, had nothing to do with any desire to help emerging markets and much more to do with the fact that he is now a "lame duck" chairman, seeing as he departs in January. Bill Gross, CEO of PIMCO, the world's largest fixed income fund, commenting on Bernanke's unexpected reversal said "Bernanke has in effect left the building, it's his successor Janet Yellen, who is in charge now." Yellen is regarded as extremely dovish, or in other words, as being in favor of accommodating policies for a good while yet - so if her appointment as the next Fed chairman is confirmed by Obama, emerging markets will find that their reprieve will go on for a while yet. However, tapering is inevitable at some point, so they only have so long to get their houses in order, their deficits under control, and those dollar loans shifted back to local currencies, before yet another Asian crisis comes upon them.