Satyajit Das: Trust is in short supply between developed and emerging countries
Das Capital: The devaluation of the US dollar has driven up the price of commodities
Tuesday 11 February 2014
Recent economic growth and prosperity has been underpinned by greater international integration and cautious increase in mutual trust. This is now breaking down.
Developed nations have chosen policies to devalue their currencies, through a combination of low interest rates and increasing the supply of money. These actions erode the value of sovereign bonds in which other nations, like China, Japan, Germany and others, have invested their savings.
Nations increasingly manipulate the value of currencies to allow them to capture a greater share of global trade, boosting growth. But a calculated policy of engineered currency devaluations to gain trading advantages invites destructive retaliation in the form of tit-for-tat currency wars. These beggar-thy-neighbour policies exacerbate international tensions, manifesting itself in trade protectionism and trade disputes.
Low interest rates and weak currencies have also encouraged investment into emerging nations, with higher rates and stronger growth prospects. These volatile money movements have the potential to destabilise these economies, derailing their development. This initially forced some nations to deploy financial repression of their own – controls on capital flows into the country. Now some countries are concerned about the flight of capital from emerging markets.
The devaluation of the US dollar has driven up the price of commodities, such as food and energy which are denominated in the American currency.
In poorer countries where spending on food and energy, including everyday essentials like cooking oil, is a high proportion of income, this has caused hardship. These developments threaten to reverse progress in reducing poverty.
Under the guise of regulations needed to strengthen the financial system, the US has implemented measures whose extra-territorial application may give American banks a business advantage. Such measures do not foster international co-operation in regulating finance.
The tension over the control of international institutions, such as the International Monetary Fund (IMF) and the World Bank, highlights increasing mistrust between developed and emerging countries.
In return for American support for their candidate for the IMF presidency (Christine Lagarde), the Europeans helped elect the American candidate (Jim Yong Kim) as the head of the World Bank. In both cases, the US and Europe used their disproportionate voting power to achieve the desired outcome.
Speaking at an IMF press conference, Brazil’s finance minister highlighted the inequality of the quotas that dictate voting power: “The calculated quota share of Luxembourg is larger than the one of Argentina or South Africa… The quota share of Belgium is larger than that of Indonesia and roughly three times that of Nigeria. And the quota of Spain, amazing as it may seem, is larger than the sum total of the quotas of all 44 sub-Saharan African countries.”
The voting imbalance is a legacy of a time when the IMF assisted ailing developing countries. But the IMF’s purpose has changed. The developed world increasingly looks to the savings of the emerging nations to help solve current debt problems, such as those in Europe.
China, Russia and Brazil have sought more evidence of “eurozone governance” before agreeing to increase financing for the IMF to assist Europe. The fact that a communist country, a formerly communist country and one which has been a recent problem child should require proof of Western Europe’s economic management credentials is ironic.
There is increasing concern in emerging markets, where incomes per head are well below Western levels, about having to take large losses to preserve the unsustainable monetary and regulatory arrangements of developed nations.
Emerging market countries also resent the fact that the IMF conditions for the bailouts of Greece, Ireland and Portugal have been noticeably less rigorous than those imposed on Asian countries in the aftermath of the 1997/1998 monetary crisis.
The tensions between developed and emerging countries is likely to tested by expected policy moves by policy makers in the US, Europe and Japan. If and when the US begins to seriously reduce its purchase of government bonds and increase interest rates to more normal levels, then the likely increase in interest rates and trigger capital withdrawals from some vulnerable emerging economies (such as the “fragile five”: Brazil, Indonesia, India, Thailand and South Africa). At the same time, expected looser monetary policies in Europe and Japan could ameliorate the effects of US policy changes but might also exacerbate other problems. A devaluing yen and capital outflows from Japan were significant factors in the emerging-market crises of the late 1990s.
In December 2013, the Governor of the Bank of England, Mark Carney, warned of a shift in risk from West to East: “The greatest risk is the parallel-banking sector in the big developing countries.”
The Governor was less forthcoming in identifying the role played by developed nations and their policies in this change.
They say that truth is the first casualty of war. International trust may be an early casualty of a global economic crisis.
Satyajit Das is a former banker and author of ‘Extreme Money’ and ‘Traders, Guns & Money’
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