Last week, The Economist ran a piece on the rather uneven relationship between the monetary power of the Fed and that of other smaller countries, such as emerging markets. In the article, the author(s) explained how Janet Yellen’s policies now influence the movement of around $9 trillion in foreign asset portfolios, out of which the “debts of the developing world, in the form of both bank loans and bonds, more than doubled, from around $2 trillion to some $4.5 trillion” in the last five years. In this context, the dollar’s position as ‘global currency’ also influences, by extension, the financial decision making of firms in these emerging markets, as well as the actions of their governments. The danger for these developing countries and their industries is an appreciating dollar. In such a case, they run the risk of becoming overburdened by rising dollar-denominated debts.
All this is true as far as it goes, and one of the most endangered countries at this time is Ukraine. Unlike Brazil or China, Ukraine’s economy is struggling to cope with the ongoing military conflict, but has only to look forward to paying back a sizeable IMF loan.
However, there’s more to the global adventures of the greenback than meets The Economist’s eye.
When these global capital flows (foreign investments or cross-border bank loans alike) are triggered by productive differences in interest rates among countries, they result in a better allocation of resources, inter-temporally and geographically. Capital goes from where it’s plentiful to where it’s scarce, to producing those goods which best satisfy consumer preferences. Nonetheless, in today’s fiat money system, such flows of capital are spurred by artificial differences in interest rates, in both the US and emerging markets. This is the natural result of the credit expansion policies which lower interest rates below their unhampered market levels. Apparently plentiful capital flows out from the US only to be mailinvested in otherwise unprofitable production processes in emerging markets. Rather than a better allocation of resources, the current global situation amounts to misallocation writ large.
Some have referred to this economic phenomenon as a “bubble-thy-neighbor” policy, or as “vagabonding” bubbles. This means that the expected consequences of the increase in the supply of dollars on US domestic economy – capital consumption, reallocation of labor into the higher stages of production, as well as the redistribution of wealth toward the first beneficiaries of the new money—have reached global proportions. Dollar debts and the artificially low interest rates they bring with them drag companies around the world into an unsustainable boom. In turn, this also lengthens the production structures of emerging markets beyond capital availability. Furthermore, as the new money enters some foreign pockets sooner than others, this also shifts the distribution of wealth within and among countries.
The real issue is therefore not one of matching dollar debts with dollar earnings. After all, wisely contracted debts should make economic sense. And changes in the exchange rate should not be an insurmountable problem for entrepreneurs, otherwise capable of adjusting contracts. The real—and special—issue about these investments and loans is that they arise in a haze of falsified monetary calculation and moral hazard. Not only are they poorly underwritten and hedged, but they no longer correspond to consumer preferences. Entrepreneurs’ reckless planning of financial and economic activity ends up consuming whatever capital stock is left, particularly scarce in the developing world.
The Fed shares the blame for this situation with a handful of other monetary authorities at the top of the world’s financial hierarchy, such as the ECB, the Bank of Japan or the Bank of England. At the same time, the governments of the developing world are not really innocent bystanders. It is true that to some extent, monetary policy spillovers are inevitable in a world with integrated financial markets. But the latter countries are being reeled into the global business cycle at their own pleasure. The effects of US monetary policies would be much reduced if other governments would not, in turn, pyramid further credit expansion on their increased dollar reserves.
