When the Federal Reserve finally starts raising interest rates, the biggest losers likely will be Brazil, Russia, Indonesia, South Africa and other emerging markets that could be thrown into economic upheaval by higher borrowing costs. But their problems are likely to be disregarded by Janet Yellen and other Fed officials.
The Fed chairwoman and others have been warning for years that they cannot keep the easy-money policies of the financial crisis in place forever and that when the U.S. economy is strong enough to raise rates from zero, they will do so regardless of what else is happening in the world.
Nevertheless, with the Fed finally poised to raise rates from zero for the first time in nine years, a number of countries appear unprepared for the move and risk having their economies damaged by it.
“I am well aware that, when the Federal Reserve tightens policy, this affects other economies,” Fed Vice Chairman Stanley Fischer said at a monetary policy conference in Jackson Hole, Wyo., last month.
Tighter U.S. money, which would further strengthen the dollar, would be an additional burden for emerging market economies that have many businesses with dollar-denominated debt.
The Bank of International Settlements, an international organization of central banks, warned in June that “massive borrowing” by emerging market businesses between 2010 and 2014 has left those countries vulnerable. Rising U.S. interest rates would make those businesses’ debts relatively more expensive and make U.S. bonds more attractive.
Those fears apparently are already being realized, with roughly $1 trillion in investments in emerging markets being withdrawn in the past year, according to NN Investment Partners.
Yet the Fed, as it is congressionally mandated, will keep its focus on the U.S. economy, Fischer said, adding, “we will be best serving the global economy as well” by targeting jobs and growth at home.
Fischer, formerly the head of Israel’s central bank, has first-hand experience with the effects that the Fed’s decisions can have on the rest of the world.
Some non-U.S. officials tasked with aiding emerging markets have sought to persuade Yellen and company not to raise rates prematurely. International Monetary Fund Managing Director Christine Lagarde has called on the Fed not to raise rates until next year and also warned that even if the Fed’s exit from stimulus is well managed, there is likely to be a replay of the summer of 2013. Then, the mere suggestion by Fed Chairman Ben Bernanke that the Fed could slow its stimulus bond purchases caused massive financial instability in emerging markets.
One official at the People’s Bank of China went so far to suggest, self-servingly, that the Fed’s talk about raising interest rates was to blame for Chinese stocks’ recent collapse.
But such entreaties will not factor into the Fed’s decision-making unless there’s a real threat to U.S. exports, said Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics and a previous staff economist at the Federal Reserve Board of Governors.
“They’re accountable to U.S. citizens and the U.S. Congress,” Gagnon said.
Yellen and Fischer have sounded similar notes in the past when responding to questions about the ramifications of their decisions for other countries.
In a speech in Tel Aviv in May, Fischer explained that the Fed would consider the rest of the world as much as it could within its congressional mandate, but that the Fed is not a “financial hegemon.” He added that he thought that the Fed’s move to tighten would “prove manageable,” if not easy, for emerging market economies and that “we have done everything we can … to prepare market participants for what lies ahead.”
The Fed’s efforts to painstakingly communicate its plans for raising rates have paid some dividends. Some emerging market central bankers, such as Raghuram Rajan of the Reserve Bank of India and Augustin Carstens of the Bank of Mexico, have said they are ready for the Fed’s rate hikes to begin.
But the larger picture is one of a world moving in the opposite direction of the U.S., with many economies facing slowing growth and looking to ease monetary policy rather than tighten it.
China’s struggles have been particularly harmful for Brazil, Russia, Indonesia, South Africa, and other commodity-producing countries that trade with China. Those four economies have seen steep currency depreciations and stock market declines in recent weeks.
Emerging market economies including those four account for just under half of U.S. exports, Fischer noted in his May speech.
Exports have been slowed by the rapid appreciation in the dollar this year, but that alone is not enough to dissuade the Fed from tightening. Exports are only a small part of total economic output, or 13 percent (currently, net exports are a drag on U.S. gross domestic product, because the U.S. imports more than it exports).
Even as the strong dollar has hurt U.S. manufacturers’ competitiveness and falling oil prices have slowed drilling, the U.S. economy has grown over the year, and the unemployment rate has fallen close to a level the Fed thinks healthy. Problems in Brazil or anywhere else won’t be enough to cause Yellen and company overlook those basic facts.
The one exception would be if China’s growth stalls enough to create a global economic slowdown that would significantly affect the U.S.
“All eyes are on China,” said Neil Shearing, chief emerging markets economist for Capital Economics, despite a likely “bloodbath” in emerging markets. Signs of problems in China are the one thing “that could tip the balance away from moving” for the Fed at its Sept. 16-17 meeting.
This article appears in the Sept. 8 edition of the Washington Examiner magazine.
