The blame game over currency crises
Sep 05 2013
There are good reasons to take the blame game seriously. First, the drop in exchange rates in leading emerging markets is beginning to harm living standards. A cheaper currency may provide a temporary boost to exporters, but importers must pay more for the goods they buy from abroad and this feeds quite quickly into inflation. Already, food sellers in Indonesia are contemplating their third price increase of the year. Second, these pressures aren’t confined to one or two nations and cannot be dismissed as problems of a few basket cases.
The blame game also matters because it influences spats over whose ox gets gored — put differently, who must adjust. Swings in exchange rates are just the first of several profound changes that customers, firms, investors and governments — at home and abroad — might face if the situation worsens. Everyone with a loud enough voice will try to shift the burden of adjustment on to others. Emerging market governments are caught in the middle, controlling some levers, responding to pressures, and, as always, worried about appearances. Many suspect that Brazil’s finance minister picked a fight in 2010 about currency wars so as to shift attention away from domestic economic weaknesses. (On the substance of that matter, as opposed to the rhetoric, I am not so sure he was wide of the mark.)
Financial investors reckon the fault lies with spendthrift governments and a private sector hampered by regulation. The last thing investors want are capital controls, so they can’t pin the blame on the ebbs and flow of finance and the guessing game that investors must undertake anticipating the extent of monetary stimuli in the west and in Japan. Ministers in emerging markets do not want to slash public budgets and anger voters, so they try to pin the blame on the developments abroad. Some firms — at home and abroad — choose such moments to redouble their calls for removing the red tape that they reckon holds their organisations back.
Dispassionate analysis — truth if you prefer — is the first casualty of the blame game. The players involved want to win the argument — to hell with awkward facts. For example, on Tuesday the OECD’s latest assessment of the global economy pointed out that those emerging markets that need to finance the largest current account deficits have seen their currencies fall the most.
While there’s some correlation between the two, it’s noteworthy that India’s rupee has fallen three times as much since May as Chile’s peso, even though Chile’s deficit is wider than India’s. As shares of their economy, China and Russia have roughly the same current account surplus, yet China’s currency has appreciated and the Russian rouble has fallen nearly 6 per cent since May.
Others take as given that the problem is vulnerability created by the financing needs of emerging markets, and then try to pin the blame on spendthrift governments. For sure, some emerging markets have large government fiscal deficits, as measured as a percentage of their national economies. South Africa and India are cases in point.
However, other emerging markets, which have seen their currencies come under enormous pressure, don’t. The fiscal deficits of Brazil, Indonesia and Turkey are smaller shares of their national incomes than the United States and Japan, yet the formers’ currencies are all down more than 8 per cent since May.
Perhaps the most galling claims relate to deregulation in emerging markets. Unless you’re prepared to argue that foreign investors had high hopes for reforms when they put their money in emerging markets, it is difficult to understand how the apparent failure to reform, or the slow pace of reforms, suddenly provides a pretext to sell. For better or for worse, national business environments do not change that quickly and certainly not fast enough to support a credible reassessment of investment prospects. This casts the drumbeat of criticism of the current Indian government in a different light.
Broad-brushed generalisations of what’s wrong don’t stand up to scrutiny. Perhaps the Anna Karenina principle applies to emerging markets as it does to families: unhappy emerging markets are unhappy in their own way? Not quite. There is at least one major point on which dissent is rare. Few dispute that the trigger to recent events was the US Federal Reserve Board’s announcement in May that it intends to progressively reduce its stimulus programme should the US economy recover.
History shows two points of interest here. First, that financial markets tend to overshoot. This exacerbates the blame game as sharp movements in financial prices grab headlines and provide an excellent opportunity for some to offer self-serving interpretations of the evidence. Second, that tightening of American monetary policy has often preceded (note I didn’t jump to conclusions and say “caused”) profound emerging market financial crises. In a world of relatively integrated financial markets, cross-border knock-on effects are pervasive.
Consequently, emerging market circumstances needn’t always account for emerging market crises. Unhappy families may share reasons for their gloom. Bear this in mind this week as the dialogue of the deaf on the global economy unfolds in, and around, the G20 leaders’ summit.
(The writer is a professor of international trade and economic development at University of St Gallen, Switzerland)