Stephen Roach: Global Economy May Be in Another Crisis Stage

Friday, 30 Aug 2013 08:18 AM

By Michael Kling

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The global economy may once again be entering another crisis stage, warns Stephen Roach, a senior fellow at Yale University's Jackson Institute of Global Affairs and former chairman for Morgan Stanley Asia.

Once again, the Federal Reserve is behind the crisis. And once again, it is insisting it's blameless, Roach writes in an article for Project Syndicate.

By pushing down rates in the United States with quantitative easing (QE), the Fed prompted investors to seek higher yields in emerging markets, Roach explains. And now, those emerging markets are floundering as the Fed plans to taper QE and "hot" money flees.

Editor’s Note:
Obama Blunder Spawns Massive Profit Opportunity

"Currency and stock markets in India and Indonesia are plunging, with collateral damage evident in Brazil, South Africa and Turkey," he states.

The troubled emerging markets all have large current account deficits. For instance, India’s external deficit will probably average 5 percent of gross domestic product in 2012 to 2013, compared with 2.8 percent in 2008 to 2011.

"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," Roach contends. "The only way to sustain economic growth in the face of such an imbalance is to borrow surplus savings from abroad."

QE provided that yield-seeking capital. In fact, emerging markets' cumulative capital inflows have reached almost $4 trillion since QE began in 2009.

The Fed, Roach argues, "remains steeped in denial: Were it not for the interest-rate suppression that QE has imposed on developed countries since 2009, the search for yield would not have flooded emerging economies with short-term 'hot' money."

The influx of capital convinced emerging markets that their imbalances were sustainable, and prompted them to attempt unviable fast-track paths to economic growth.

"This is an endemic feature of the modern global economy," Roach maintains, saying emerging markets chose unsustainable growth that ultimately backfired instead of a slower, sustainable path.

"Developing economies are now feeling the full force of the Fed’s moment of reckoning," he writes. "They are guilty of failing to face up to their own rebalancing during the heady days of the QE sugar high. And the Fed is just as guilty, if not more so, for orchestrating this failed policy experiment in the first place."

Other economists agree with Roach's assessment, although most are not as critical of the Fed.

N.R. Bhanumurthy, a professor at the National Institute of Public Finance and Policy in New Delhi, agrees that the Fed's plan to shrink QE prompted investment outflows from emerging markets and that the hardest hit countries have high current account deficits, according to USA Today.

"This is short-term volatility backed by foreign capital outflow and my guess is that it's speculative outflow, and the market will balance itself out in the next few months, maybe even weeks," Bhanumurthy told USA Today.

Editor’s Note: Obama Blunder Spawns Massive Profit Opportunity

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