Money and its dislocations


Linda Yueh looks at how the actions of the US Fed are felt in fragile countries such as Indonesia

Is the world ready for the end of the era of cheap money? It's not just what the Fed says about QE, but interest rates that will matter for the recovery for the US and the extent of the dislocations for emerging economies.

For emerging economies, they have seen money leave their borders and falls in their currencies.

The Fed meeting today, the last under Chairman Bernanke, is widely expected to cut back further on monetary stimulus. Since he first signalled it last May, to when the "taper" was first announced last December, emerging economies have been braced for the inevitable.

But, the emergency actions and rate hikes from Turkey to India, two of the Fragile Five economies that are viewed as most at risk, suggest that it will be a bumpy course for monetary policy to get back to normal, after five years of extraordinary cash injections and 0% rates.

Since last May, I have written about the Great Reversal and how money leaving emerging economies had been triggers for crises before. There was a period of calm after a tumultuous summer but emerging economies are again battling to keep money flowing in.

Scale of the challenge

Turkey held an emergency meeting and raised its benchmark interest rate (one-week repo rate) to 10% from 4.5%. Yes, that's more than double, and there were similar hikes to its lending and borrowing rates that brought them all into double-digit territory. India also raised its key rate to 8% earlier in the week, and South Africa just unexpectedly hiked rates to 5.5%.

Raising interest rates aim to attract money to increasing the return to investors and it props up the currency since more investment increases the demand for the currency. For the Turkish lira that had recently hit record lows, the central bank's actions boosted it straightaway but the currency has fallen again within a day, underscoring the scale of the challenge.

The World Bank estimates that 10% of capital equal to 0.6% of the GDP of developing countries could stop flowing into those countries with Fed taper. The figure could rise to a staggering 80% if there is severe market dislocation.

With emerging economies' currencies down between 10-20% since May and continuing to decline in January after December's taper announcement, the movement of capital is evident.

The situation also gets trickier for these economies since a weaker currency means that imports are more expensive, which doesn't help inflation in places like India where CPI is about 10%, the highest in Asia.

'Exit strategy'

When I spoke to a small businesswoman in Jakarta who imports parts for her factory, she was concerned about the value of the Indonesian rupiah since it would increase her costs.

Indonesia, along with Brazil which is yet to be mentioned, and the other countries that I've discussed (Turkey, India, South Africa) have been dubbed the Fragile Five for having worryingly large current account deficits which relies on money flowing in to finance.

And a weaker currency makes it more expensive to finance the widest measure of the trade deficit plus investment flows, which is why there have been rate hikes that hurt growth but are intended to stabilise the short-term macroeconomy.

So, coming back to the Fed meeting today.

The Fed's mandate doesn't extend to its global impact and though they are likely to be mindful of it, the focus of Bernanke in his last meeting will be to manage the "exit strategy" from unconventional monetary policy of quantitative easing or QE.

The Fed is expected to announce a steady withdrawal of cash injections which could mean another trimming by $10bn of the current $75bn, which is down $10bn from the original $85bn. At this pace, in the course of the Fed's eight meetings this year, the Fed will have exited QE by 2015.

The Fed faces a further challenge, which is to manage expectations that rates will rise. After all, unemployment has fallen to 6.7% which is close to 6.5%, the threshold that they set for themselves under "forward guidance" to hit before considering raising rates.

Convincing markets that as the recovery picks up, borrowing costs should stay low will be the challenge. After all, as the US economy recovers, demand will rise and so will prices. For lenders, they will want to ensure that they have a return after inflation.

This is why borrowing costs have been inching up as seen in the yield on 10-year Treasuries, now at around 2.7%, which is closer to 3%, versus being below 2% a year ago. But, if rates go up too quickly, then the recovery could be choked off.

Political risk

This is why although the Fed taper has significant global implications, interest rates may be more important moving forward. It's not just for the US economy, where unemployment is still far from the 5% that it usually falls back to rather quickly after a recession, that it isn't happening this time.

But it's also because the US interest rate is the benchmark for global markets. If the US interest rate rises, then emerging markets aiming to attract money into their borders will need to raise rates even more to attract capital.

Investors may be happy with a 3% return and minimal inflation in the US and need a greater interest rate differential or return to take the risk of putting funds into an emerging economy.

It's not just economic risk, but also political risk in places like Turkey as well as upcoming elections in the rest of the Fragile Five. Or a much wider set of issues when it comes to Argentina.

The Fed will focus on setting out a course to "exit" today. But, for many in the US worried about their mortgages and business loans, as well as the rest of the world looking to attract capital, the price of money - the interest rate - will be the key to watch.

Linda Yueh Article written by Linda Yueh Linda Yueh Chief business correspondent

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  • rate this

    Comment number 31.

    Serves them right for being so successful.
    The Wolf of Wall Street has probably had it to buy drugs.

  • rate this

    Comment number 30.

    All those emerging economies have known from the lessons of Asian financial crisis of 1997 that cheap/hot money cannot last forever. The impact of Fed tapering and capital outflow from these countries this time around would not trigger a crisis like last time, but still worrying judging from the stock markets' reactions.

  • rate this

    Comment number 29.


    Very true. The published unemployment number in the US is U-3, which excludes many categories including - believe it or not - "discouraged workers".

    Add these excluded groups back in and you get the official U-6 number, still well in double-digits.

  • rate this

    Comment number 28.

    If policy is based on corrupted statistics the result is corrupted policy.

    The only way US unemployment has fallen to 6.7% is by not counting vast swathes of "discouraged workers". Why not check out labor force participation rates. You may get a very different answer, and this may tell us something about the true intent of QE.

  • rate this

    Comment number 27.

    Hope I don't sound too pedantic but for me tapering is not exiting QE,the Fed is still expanding it's balance sheet currently circa $4 Tn, pre crisis it was circa $800 Bn. Only when the Fed starts to reduce it's balance sheet can we say the exit has begun.To quote Churchill after El Alamein, "This is not the end. It's not even the beginning of the end.But it is,perhaps,the end of the beginning."

  • rate this

    Comment number 26.

    Hey Linda, re. 23... what's the Fed saying about the lack of gold in their vaults? Or the lack of the useless yellow metal in general compared to the paper ponzi contracts? Must have been all those 'de rigeur' MTFs...

  • rate this

    Comment number 25.

    But rememberdurr....

    The debt pays interest at a range of rates depending on when it was issued. It is only the new borrowings that will draw a higher interest if rates rise but then it would only happen with higher growth which will bring in more than sufficient taxes and reduced borrowings (less unemployment etc.) to cover the extra interest costs

  • rate this

    Comment number 24.

    A 'taper' means just that, a steady reduction month on month which is what I said when the reduction was first mooted. Some people seemed not to understand, it has to be this way in order to exit QE by years' end. So $10bn less each month barring economic reversals. With interest rates other factors besides unemployment will be considered, this is what 'forward guidance' said both in UK and US.

  • rate this

    Comment number 23.

    Earlier this year Germany asked to see its bullion stored in the FED.
    After a lot of excuses it was admitted that their gold ( Bundesbank stamped) could not be located but not to worry because the FED would replace it with somebody else's... WHAT?!

    The suggestion is that Germany's stamped gold has been flogged off to someone else.

    The implication is that there is little or no gold in the vault!

  • rate this

    Comment number 22.

    Why are they called "emerging" markets.
    Would "submerging" not be more appropriate?

  • rate this

    Comment number 21.

    Global events are taking over the FED's choices, as more countries raise interest rates money become more expensive. Hence you will see the EU Central Bank, BoE and the Fed be forced to make a move sooner rather than later. Or risk being exposed to the markets and the hawks.

  • rate this

    Comment number 20.

    All my money got dislocated a long time ago.

  • rate this

    Comment number 19.

    the world must focus on growth per person rather than just growth, and do this in a climate of liquid fuels usage growing very little and increasing in price on average 7% per year in real terms. Big challenges in a finite world where energy substitutes must be found quickly and inevitably energy from fossil fuels must be reduced due to global warming and drop in fuel quality and increase in price

  • rate this

    Comment number 18.

    40 Minutes ago

    This comment was removed because the moderators found it broke the house rules. Explain.

  • rate this

    Comment number 17.

    Zero interest rate policy is punishing savers in the United States and other countries. With big corporations and Wall Street awashed with trillions of dollars, there is no need for the American taxpayers to support the world's financial markets forever. I again call for an immediate end to QE. Plus the US, UK and other developed powers to raise short term interest rates now!

  • Comment number 16.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • rate this

    Comment number 15.

    "The Fed faces a further challenge, which is to manage expectations that rates will rise... unemployment has fallen to 6.7% which is close to 6.5%, the threshold that they set for themselves under forward guidance to hit before considering raising rates."

    Why don't they just say "err...scratch that" like the BoE have just done to try and make sure the asset bubble keeps going to the election?

  • rate this

    Comment number 14.

    Somebody commented about end of QE not being the exit but end of the entry of QE, exit being selling the purchases.

    If QE is money printing, end of QE is end of further printing; selling the purchases is burning the money that was newly printed.

  • rate this

    Comment number 13.

    The City needs the carry trade. If domestic rates rise, there is no margin. So collusion with government vs citizen savings is crucial. It;s important to not have to pay fair market for savings.

  • rate this

    Comment number 12.

    There is a dominant logic to drawing down accomodative monetary policy. Besides ever only being the stop gap political jeopardy of financial rescue, the over bearing lesson is that of interest rates and excessive margin in economies which will not tax effectively.

    Greenspan's logic back in.... 2002 is classic. EM's will do ok once they pay up :)


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