Stern words today about the roots of the current emerging markets crisis from Stephen Roach, the former chief economist at Morgan Stanley now less stressfully ensconced at Yale University, where he is a senior Fellow. You can read the full broadside here, but this is a short extract, highlighting how the huge destabilising capital flows into – and now out of – emerging markets can be directly traced back to the policy of quantitative easing. The countries now suffering most are those, such as India and Indonesia, which have run large current account deficits and/or have failed to make necessary structural reforms during the good times:
A large current-account deficit is a classic symptom of a pre-crisis economy living beyond its means – in effect, investing more than it is saving. The only way to sustain economic growth in the face of such an imbalance is to borrow surplus savings from abroad. That is where QE came into play.
It provided a surplus of yield-seeking capital from investors in developed countries, thereby allowing emerging economies to remain on high-growth trajectories. IMF research puts emerging markets’ cumulative capital inflows at close to $4 trillion since the onset of QE in 2009. Enticed by the siren song of a shortcut to rapid economic growth, these inflows lulled emerging-market countries into believing that their imbalances were sustainable, enabling them to avoid the discipline needed to put their economies on more stable and viable paths.
This is an endemic feature of the modern global economy. Rather than owning up to the economic slowdown that current-account deficits signal – accepting a little less growth today for more sustainable growth in the future – politicians and policymakers opt for risky growth gambits that ultimately backfire. That has been the case in developing Asia, not just in India and Indonesia today, but also in the 1990’s, when sharply widening current-account deficits were a harbinger of the wrenching financial crisis of 1997-1998. But it has been equally true of the developed world.
This is, unfortunately, true. The failings have been a feature of policymaking since the start of the century. The world is crying out for a return to more disciplined policymaking, in which both money – the rate of interest – and financial asseets generally are priced realistically by market forces, rather than by well-meaning but misguided government and central bank interventions.
The beginning of asset purchase tapering by the Federal Reserve, assuming it happens this autumn, as the markets now expect, is ironically a welcome step down that path, but it can’t disguise the fact that there will be casualties along the way. Although emerging markets are much better insulated against capital runs than they were during the Asian crisis of 1997-98, they are first in the firing line, and many are also reaping the rewards for past policy failures of their own.
Mr Roach’s conclusion is not encouraging: “with more than a dozen major crises hitting the world economy since the early 1980s, there is no mistaking the message: imbalances are not sustainable, regardless of how hard central banks try to duck the consequences”. The global economy, he says, could be in the early stages of another crisis.