Don't Blame Western Monetary Policy For Emerging Market Woes

02/21/2014 04:03 pm ET | Updated Feb 22, 2014
  • Nathan Gardels The WorldPost
ChinaFotoPress via Getty Images

The following is an excerpt on the role of the G-20 from a speech by Britain’s Chancellor of the Exchequer, George Osborne, given at the British Chambers of Commerce in Hong Kong on Feb. 20.

G-20 finance ministers are meeting in Sydney, Australia this weekend.

You can find the full speech here.

HONG KONG -- We might have hoped that this would be the first time in five years that the G20 has met outside of a global crisis.

The risk of a eurozone collapse has greatly receded, and the prospect of a destabilizing standoff over the U.S. fiscal position now looks much less likely.

But as well as reasons to be cheerful, there are also reasons to be careful.

Many economies in Europe remain very weak.

Problems in the Middle East abound.

And in recent months, we have seen volatility in several emerging markets, with currencies weakening by up to 19 percent, bond yields spiking by up to 11 percent and sudden falls in equities markets across Latin America and Asia.

Most emerging markets are more robust than they were in the late 1990s, and in many cases flexible exchange rates are functioning correctly as shock absorbers.

But if we have learnt anything from the recent Great Recession, it is that in this interconnected global economy, one country’s problem can very quickly become everyone else’s problem.

And acting early when risks emerge can head off much greater damage later on.

My message here in Hong Kong is this:

The risks to economic recovery have not gone away.

Together we need to act now to ensure that emerging market problems don’t contribute to a new crisis.

"The risks to economic recovery have not gone away. Together we need to act now to ensure that emerging market problems don’t contribute to a new crisis."

How do we do that?

By each one of us putting our own houses in order.

And by using the G20 to make sure we all confront our problems instead of running away from them.

As we meet in Australia, the G20 is more than capable of doing that, provided we focus on the important issues.

But there is a danger that in Sydney and other such meetings we find ourselves distracted by a pointless debate about U.S. and U.K. monetary policy…

…that the G20 descends into a blame game…

…and we miss the opportunity to drive through, together, the reforms that are necessary to safe-guard the global recovery.

To avoid that happening, we need to understand better what the last six years have taught us about how global coordination works.

In particular, we need to understand that international coordination can work and has worked when it holds governments to account for domestic reforms, but not when it tries to impose global macroeconomic policies that are against countries’ own self interests.

Fostering domestic resilience from the bottom up is the best way to build global resilience at the top.

For example, many people have identified global macroeconomic imbalances between surplus and deficit countries as a major contributing factor to the Great Recession a few years ago.

With some exceptions, those macro imbalances have now dramatically reduced –- China’s current surplus came down from over 10 percent in 2007 to 2.3 percent in 2012, and the U.S. current account deficit fell from 4.7 percent in 2007 to 2.7 percent in 2013.

Has this therefore been a triumph of external pressure against U.S. and Chinese self-interest?

That would obviously be a misunderstanding of the real forces at work.

China has not reduced its current account surplus because of external pressure by international bodies like the IMF or the G20 -– it's done it because the Chinese understand it is in their self interest to move away from an investment and export led model of growth towards something more sustainable.

In fact, it is hard to find examples in history of a surplus economy taking action to rebalance demand in response to external pressure.

Equally, the U.S. has not reduced its current account deficit because of international pressure –- it has been a product in large part of the shale revolution and improved U.S. competitiveness. Indeed, we can go further -– the initial macro imbalances were not in themselves the major cause of the crisis.

Capital flows from East to West and from surplus countries to deficit countries did indeed reduce global interest rates. But those low interest rates did not induce financial crises in countries with robust domestic frameworks. Canada did not have a banking crisis or a fiscal crisis. Nor did Sweden. It was not the overall net flows from East to West that turned out to be the problem.

It was poor domestic regulation in the U.S. and much of Europe of some specific capital flows –- particularly into housing and commercial real estate assets –- and poor domestic regulation of the banks that held many of those assets.

Equally, it was poor economic and fiscal management in many of those same countries which left their economies so vulnerable to the ensuing banking crisis.

None more so than the U.K. We went into the crisis with the biggest structural deficit in the G7 and with the most leveraged households and banks of any major economy and we paid a heavy price for that failure of policy.

And, of course, it was the underlying flaws in the institutions of European monetary union that made the impact so catastrophic and long lasting in the eurozone.

So, in fact, it was a lack of resilience at a national level in several important economies that created a lack of resilience at a global level.

Exactly the same is true now when we look at the risks in emerging markets.

I can see that it is tempting for some to blame Western monetary policy for economic problems in some emerging markets, but this is neither accurate nor useful.

"I can see that it is tempting for some to blame Western monetary policy for economic problems in some emerging markets, but this is neither accurate nor useful."

Not accurate because, while tapering of U.S. monetary policy in response to a strengthening domestic recovery may have been the trigger for instability, it is not the real cause.

The underlying causes are domestic fragility in those countries, often built up over a long period of time –- and that is why some emerging markets have been much more affected than others.

And blaming Western monetary policy is not useful because it doesn’t lead us to any sensible solutions.

The Fed does not -- and indeed should not -- set monetary policy to be appropriate for emerging markets. The Fed has a legal and democratic requirement to set monetary policy to be appropriate for the U.S. economy.

The fact that it is currently tapering its program of quantitative easing is a sign of success.

Equally, I know that U.K. citizens would be rightly outraged if Mark Carney and the Bank of England set U.K. monetary policy decisions on the basis of what was best for other economies. So at this G20, we should avoid finger pointing and distractions.

There is an alternative.

The alternative is to focus on building domestic resilience –- not just in emerging markets, but also in developed economies.

The alternative is to use the G20 to hold governments accountable for these domestic reforms, rather than allowing them to escape accountability by blaming their problems on others.

And that alternative is exactly the plan put forward by my colleague Finance Minister Joe Hockey and the Australian presidency.

Under that plan, the G20 members will sign up to comprehensive and ambitious national reform agendas -– and then hold each other to account for delivering them.

That is exactly the right approach because it tackles the underlying problems head-on. I’m ready for the U.K. to play its part, and I hope this approach is adopted by the G20 later this year. We all need to get our houses in order.

We all have to put in place the four fundamentals necessary for economic security: responsible fiscal policy; credible institutions; effective financial regulation; and crucially, the long term structural reforms that will deliver lasting prosperity.

It is a lack of these foundations that caused the financial crisis in developed economies and the recent troubles in some emerging markets.

Just look at those developed economies who had these foundations for economic security in place, and how much better they performed in the financial crisis.

Look at Australia, where I’m heading tomorrow. Thanks to robust financial regulation and the reforms of the John Howard government many years ago, they grew through the crisis when many others were shrinking.

Or look at Canada, which was also in control of the risks in its financial system. It bounced back from the 2009 crisis extremely quickly –- by 2010, it was growing by 3.4 percent!

The same is true of Sweden, which grew by an astonishing 6.6 percent in 2010 and then 2.9 percent the year after that.

Unsurprisingly, we see the same pattern with emerging markets now -- those that had the fundamentals in place, that have taken the difficult decisions to reform, have avoided the worst of the volatility.

Compare the relative calm we’ve seen in countries like Mexico and Peru with the experience of some of their neighbours.

Look at Malaysia, now growing at 5.4 percent.

And we have also seen other economies taking up these reforms, to head off future threats.

Last October, for example, I was speaking to the Vice Premier of China, Ma Kai, about China’s comprehensive economic reform plan.

The plan that the Chinese leadership went on to set out at the Third Plenum tackles exactly the fundamentals I’ve talked about: By allowing markets to play a greater role; strengthening financial sector regulation, including around shadow banking; and establishing the next generation of free trade pilot zones to boost trade and investment.

And as a result, I am confident that when these reforms are implemented, they will not just make China more resilient, but they will also make the whole global economy more resilient.

This is where global coordination can be really effective.

We’ve already seen that the G20 works when it focuses on the painstaking process of coordinating reforms and holding governments to account for delivering them.

The G20 has played a crucial role in reforming financial regulation, setting deadlines for agreement and tasking the Financial Stability Board and Basel committees to meet those deadlines.

Now Basel three is being implemented; so too, new global rules on derivatives; and as Mark Carney has said, this year we must secure an international solution to the too big to fail problem in banking. The G20 can resist moves to global protectionism -- as it has done remarkably well in these recent years –- and promote new trade agreements.

The G20 and the IMF have important roles in coordinating balanced and responsible fiscal consolidation plans, though there is still more to do.

And because the British Prime Minister, David Cameron, put international tax evasion and tax avoidance at the center of our G8 Presidency, the Australian Presidency of the G20 has been able to pick up the baton and for the first time we have the real prospect of new, tough and fair global tax rules.

This kind of international cooperation works.

And so the Australians are completely right to take this to the next level and ensure we have comprehensive plans to make our countries more resilient.

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