America's unilateral money policy signals global damage

Den Steinbock   2014/4/3 source：Shanghai Daily

Despite its global implications, the Federal Reserve is focused on the US economy primarily.

The Fed chair Janet Yellen announced that interest rates could start rising in "around six months" after the Fed stops tapering bond purchases in late 2014. As a result, global markets, which were expecting a much longer lead time, took a hit.

However, the emerging market turmoil has only begun. It is likely to get worse in the coming months. But nor will the Fed's tapering spare the lingering recovery in the major advanced economies.

Of course, several emerging economies have challenges of their own, including budget and trade deficits, relatively high inflation and excessive reliance on commodity-led growth.

However, these challenges did not come out of the blue. They were amplified in June 2013, when the Fed first flirted with tapering, and escalated after December 2013, when the actual tapering was initiated, which caused a reverse "hot money" tsunami in emerging markets.

Before the global financial crisis, the Fed's policy rate exceeded 5 percent. By December 2008, Bernanke had cut the rate down to 0.0-0.25 percent, where it remains today.

Following the Fed's footprints, other central banks in major advanced markets first exhausted the traditional rate cuts and then opted for non-traditional instruments, including rounds of quantitative easing (QE).

In advanced markets, which suffer from stagnation, and emerging markets, which remain fragile, the Fed's moves have potential to cause "collateral damage."

But what is less understood is that these very same moves are paving a way to a huge liquidity risk. Following the Fed's tapering and the depreciation of currencies, some central banks in emerging markets have been intervening in the market to curb depreciation pressures on their currencies. They have offered US dollars via foreign-exchange swaps — from the currency swaps of Brazil's central bank BCB to India's dollar/rupee foreign exchange swaps and Indonesia's turn to liquidity management tools to contain credit growth and import demand.

At best, such liquidity management can buy time to focus the nation on the fundamental challenges. At worst, it can serve as a moral hazard, which will defer depreciation, while causing losses from the swaps and, eventually, sovereign ratings downgrades.

Real dilemma

Although US fiscal and monetary policy has global consequences, the Fed's focus is mainly on US employment and US prices.

Ironically, with its unilateralism, the Fed is pushing central banks in emerging markets to rely ever more on US dollar-denominated liquidity management — even though the dominance of the US economy, finance and dollar no longer exists.

And that, precisely, is the real dilemma. In a nascent multi-polar world, it is impossible any longer to conduct unilateral monetary policy without substantial "collateral damage."