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Everyone will suffer from emerging market turmoil – eventually

Everyone will suffer from emerging market turmoil – eventually

Rajan should direct spleen at euro area

by David Marsh

Mon 3 Feb 2014

One of the most chilling phrases in the political-economic lexicon is ‘We’re all in this together’. The translation is ‘You are all going to pay.’

The expression is employed in calls for bogus solidarity in the euro area, to heal divisions over taxation and employment in the UK, to stoke ‘one nation’ bipartisanship in Barack Obama’s America or to gain Chinese citizens’ support for a new Beijing economic model.

We see it again during the gathering storms over emerging market economies. Whenever, on the basis of supposed common interest, one nation or group of people appeals for backing from another, you can be sure that it’s going to cost you a great deal of money.

The latest example is criticism by Raghuram Rajan, Governor of the Reserve Bank of India, of alleged selfishness from the US and other industrialised countries contributing to unrest in emerging markets.

The gist of the argument is that the Federal Reserve should take care with ‘tapering’ its monetary stimulus which earlier sparked enormous capital flows into developing countries.

Damaging outflows from these emerging markets, Rajan says, will end up hurting the west, which in its own interest should rekindle the global policy solidarity that helped pull the world out of the 2008 crisis.

We saw the same arguments at the International Monetary Fund’s annual meeting in Washington in October. Ben Bernanke, then Fed chairman, issued an emollient statement that the Fed was indeed taking everyone’s sensitivities into account.

A less mealy-mouthed rebuff came last week from Dallas Federal Reserve Bank President Richard Fisher, who defended the Fed from complaints that it was ignoring the impact of tapering on other countries.

‘Some believe we are the central bank of the world and should conduct policy accordingly. We are the central bank of America,’ Fisher said. Fisher’s rebuke echoed the underlying psychology of the defence brandished by Angela Merkel, the German chancellor, against charges that Germany is running an exaggeratedly high current account surplus.

As an arithmetical inevitability, Berlin’s critics say, Germany is complicating other countries' task of funding the ensuing deficits. Merkel responds by saying that any policy of restraining German competitiveness would be bad for the rest of the world.

Ultimately, the arguments wielded by Fisher and Merkel will win the day. Stronger nations accused of egoism will always have the upper hand over weaker ones forced on to the back foot.

The wiser heads in emerging market economies have always known that slower US bond-buying, when it eventually came, would be painful.

That includes officials in some countries such as Brazil, Turkey, South Africa and Indonesia hardest hit by the past few weeks’ market backlash.

Rajan’s claim that ‘international monetary co-operation has broken down’ detracts attention from the real issues. His comments represent an underlying protest against the immobility of the Indian political and economic system that has prevented the country from taking timely preparatory action to protect it from an ending of the Fed’s monetary injections.

Undoubtedly, though, there is truth in the argument that restrictive policies in different parts of the world – even though carried out for ostensibly sensible domestic reasons – send out growth-retarding ripples into other regions.

In the end, everyone will pay for the resulting slowdown.

Rajan’s spleen should have been targeted not on the US but on the euro area, given the combined monetary and fiscal squeeze in the region. The single most damning statistic is that the euro area (including some countries with the biggest surpluses such as Germany and the Netherlands) has developed from a region with a current account deficit of $96bn or 0.7% of combined GDP in the pre-recession year of 2008 to a surplus of $295bn or 2.3% of GDP last year.

The turnaround of nearly $400bn in the euro area’s current account performance was necessary to damp economic overheating in errant peripheral countries. But it has necessarily added to other countries’ problems, as Rajan’s expression of frustration showed.

The euro area, too, will get caught up in the emerging market turbulence, as lower demand for German exports eventually feeds through into bad news on the European mainland. So Rajan has a point. We are all in this together. But some will feel the anguish earlier than others – and with more distress.

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