Emerging countries, particularly those running high current account deficits (CAD), have been facing a “sudden stop” event since investors reacted to the US Federal Reserve's intention to scale down its quantitative easing (QE) policy by shifting their portfolio preferences in favor of US-dollar-based assets. These capital outflows are causing the depreciation of the local currencies of emerging countries, increasing interest rates and decreasing gross domestic product (GDP) growth rates. This slowdown is considered to be a new threat to the global recovery that remains quite fragile. Countries such India, Brazil, South Africa, Indonesia and Turkey have had their currencies depreciate remarkably in recent weeks, requiring these economies to make harsh adjustments. These ongoing adjustments could prove detrimental to the global recovery if the imports of these countries continue to shrink along with their declining economic growth.
This threat was widely discussed at the recent G-20 summit in St. Petersburg. However, the suggested remedies were essentially limited to recommending moderation to the Fed when it begins tightening its monetary policy. Obviously, moderation by the Fed, even if it occurs, cannot be a solution to the turmoil that emerging countries are suffering. So the question is: Are there other possible responses?
Recently, several prominent economists published articles on this topic through the website of Project Syndicate. The most interesting of these articles, at least from my own viewpoint, is one by Daniel Gros entitled “Emerging Markets' Euro Nemesis.” Gros, director of the Center for European Policy Studies, thinks that the true reason behind the troubles in emerging markets will be found somewhere other than over the Fed's QE policy, which has fueled money markets with excessive liquidity, depreciated the US dollar and pulled capital inflows that had caused the appreciation of local currencies and high CADs. According to Daniel Gros, the Fed's policy is only the readily apparent reason, not the root cause. “The real culprit is the euro.”
Daniel Gros suggests focusing on external balances. He argues that “quantitative easing in the US cannot have been behind these large swings in global current-account balances, because America's external deficit has not changed significantly in recent years.” Export and import increases in US had a no real impact on external balances, but austerity in Europe had a profound impact. The eurozone's 2008 CAD of $100 billion became a surplus of $300 billion in 2013. The two reasons behind this $400 billon shift are, on the one hand, the austerity raging in south European countries and, on the other hand, the refusal of surplus countries, such as Germany and the Netherlands, to expand their internal demand. Gros wrote: “This extraordinary swing of almost $400 billion in the eurozone's current-account balance did not result from a ‘competitive devaluation'; the euro has remained strong. So the real reason for the eurozone's large external surplus today is that internal demand has been so weak that imports have been practically stagnant over the last five years (the average annual growth rate was a paltry 0.25 percent).”
Nowadays, capital withdraws from emerging countries are forcing those countries to adopt their own austerity programs that will tremendously decrease their CAD. At this point, Gros asks the critical question “who will then be able -- and willing -- to run deficits?” According to Gros, the first two of three candidates -- China, Europe and the US -- are committed to running large surpluses. So, if the US does not endorse its role as “consumer of last resort,” global recovery can hardly be pursued.
We return, at this point, to the basic problem of global imbalances. Admittedly, China and Germany must absolutely increase their domestic demand so they will be able to increase their imports and decrease their gigantic current account surpluses. I know that this implies difficult maneuvers: The switch in the growth regime from export-led to one of domestic demand must be done without damaging the growth dynamic. This will take time. On the other hand, south European countries should be freed from austerity programs as soon as possible. As noted by the International Monetary Fund (IMF) and reiterated by Kenneth Rogoff in “Are Emerging Markets Submerging?”, published by Project Syndicate, the fund “should place much greater emphasis on debt write-downs and restructuring than it has in the past.” However, the problem is who will pay the bill.
Large deficits on the one side and large surpluses on the other allowed the world's economic engine to run well. However, the Great Recession has clearly shown that this state of affairs cannot be pursued vitam aeternam. Unfortunately, we do not know how to bring it back into balance.