The latest financial turmoil–where concerns about emerging markets have spread to all corners of the market–is offering a stark reminder of how interconnected the world’s economic and financial systems have become and of how our policy makers are out of touch. It isn’t that these smart people don’t grasp the realities of globalization; it is that they are working within outdated political frameworks that assume economies are isolated and independent.
Despite analysts’ assurances that Turkey’s economic problems are Turkey’s problems alone, they–as well as those of Thailand, South Africa, Argentina and Russia–have sparked a synchronized selloff in world markets. The impact on consumer and business confidence is such that economists are sharply downgrading their forecasts for the global economy.
Ms. Lagarde’s plea should be heeded. Yet the attitudes of the major central banks suggest her call for closer cooperation will get mere lip service. At best, we will get a statement of intent at the Group of 20 finance minister and central bankers’ next photo op–I mean, meeting–during the IMF’s spring meetings in Washington.
In 1997, the last time an emerging-market crisis triggered global contagion, the problems lay in leverage and currency reserves–financial institutions had too much of the former and emerging-market central banks had too few of the latter. Because those problems have since been rectified, pundits tell us we’re safe now. But this ignores other ways our economies have become even more vulnerable to self-feeding cycles of anxiety.
Today, global interconnections and systemic risks arise through real-money investors and multinational companies rather than overleveraged hedge funds. That wouldn’t matter if emerging-market funding was entirely comprised of long-term direct foreign investment. But in the post-2008 period it was dominated by “hot money,” as aggressive monetary stimulus from the Federal Reserves and other major central banks sent cashed-up fund managers in search of higher yields. Unprecedented correlations arose across markets as differentiation and bond-yield spreads narrowed. Now, with the Fed starting to unwind that stimulus, global investors are rushing for the exit. The correlation remains, only in the other direction.
Yet in its policy statement a week ago, the Fed made no reference to the global market maelstrom. The message: it doesn’t care about the overseas side-effects of its policies.
That was a big mistake. While the Fed needs to taper a bond-buying program so as to rectify the market distortions it has created, it owes it to the other countries to acknowledge its role in their plight. The Fed needs to at least hint that it is ready to help–perhaps via currency-swap agreements, the instruments it used to calm global markets in 2009.
The Federal Reserve’s mandate is defined by U.S. economic interests, which is as it should be. But that’s no excuse to adopt an isolationist posture that ignores the realities of modern global financial integration. It is time to listen to Christine Lagarde
