The hallmark of US economic policy-making in the age of President Donald Trump is insularity. This is particularly the case with emerging markets, which account for more than half of world economic output and have been the main engine of global economic growth. The international financial market repercussions of the Turkish economic crisis provide ample forewarning. In ignoring the plight of emerging markets, the US is steering a perilous course.
Prime examples of US policy insularity include Trump’s large unfunded tax cut and his support for public spending increases at a time when the US economy is at close to full employment. Such a budget policy is forcing the Federal Reserve to be more restrictive than it would otherwise have to be and is thereby adding strength to the dollar. This combination of higher US interest rates and a rising dollar is causing an abrupt reversal in capital flows to the emerging markets.
Trump’s ‘America first’ trade policies provide yet another example of Washington’s seeming disregard for emerging markets. Engaging in a trade war with China, which is trying to rein its credit bubble, is bound to exacerbate the country’s economic slowdown. This is especially worrying when one remembers that China is the world’s main consumer of international commodities.
The imposition of punitive tariffs on aluminium and steel exports from Turkey, which is in the midst of a currency crisis, is similarly ill-advised. By not extending a lifeline to Turkey to help stabilise its economy, Trump is breaking with 70 years of US emerging market crisis management. This does not bode well for future US involvement in other emerging markets where contagion may spread, such as Brazil in the run up to its presidential election in October.
Further instances of US insularity can be found at the Federal Reserve. After years of flooding emerging markets with easy money under its quantitative easing programme, the Fed is now normalising its monetary policy without, it appears, paying due attention to its impact on those markets.
To be sure, the Fed’s dual mandate obliges it to focus on how its policy actions impact domestic inflation and employment. However, it should remain mindful of the potential for its decisions to precipitate economic and financial crises abroad. As became clear during the 2008 financial crisis, a crisis in any systemically important country can have major spillover effects for the rest of the global economy. Such spillovers could impede the Fed’s ability to meet its inflation and employment objectives.
According to the International Monetary Fund, never have emerging markets been as indebted in relation to their overall output as they are today. At the same time, rarely before have emerging market investors been so poorly compensated for the risk they take on in lending to these markets. As in 2008, when the collapse of a small US investment bank managed to destabilise the rest of the global economy, an emerging market crisis could derail the US economic recovery.
An appreciation of these risks should encourage US policy-makers to take emerging markets into greater account in setting US economic policy. However, judging by Trump’s adherence to his ‘American first’ agenda, the US should be bracing itself to weather the economic effects of a major emerging market storm well before the November mid-term elections.
Desmond Lachman is a Resident Fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund’s Policy Development and Review Department and the Chief Emerging Market Economic Strategist at Salomon Smith Barney