A Global Solution to Monetary Policies

What helps the United States can hurt emerging markets. José Antonio Ocampo, former under-secretary-general of the United Nations, argues for a unified approach that will benefit everyone.
Jose Antonio Ocampo |  April 11, 2013
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The US Federal Reserve’s continuing policy of quantitative easing will keep interest rates low in the major world’s economy for years to come. That may be good and necessary for the US economy. But for emerging-market countries, these expansionary measures (and those of European Central Bank and the Bank of Japan) only add fuel to the fire by creating strong incentives for international investors to export capital to higher-yielding emerging economies. That, in turn, leads emerging-market countries to struggle with the rapid currency appreciation that negatively impacts their competitiveness.

These types of massive capital inflows have historically led to exchange-rate overvaluations, rising current-account deficits, and asset-price bubbles. In fact, it is already happening: the only parts of the world in which current account deficits are growing are emerging markets. Past experience has taught us that this is a recipe for future crises.

I agree that the Fed has few options left to support and kickstart the US economy. Political gridlock in Washington has made it impossible to stimulate the economy by boosting government spending, and the ongoing sequester is threatening to weaken the US economy even further. Given that the US dollar is the dominant global currency, though, this expansionary monetary policy can have dire effects on the rest of the world.

This is a particular concern for Latin America, which, for the first time in 30 years, managed to avoid a financial meltdown during the global financial crisis of 2008 and 2009. Between 2003 and 2007, Latin America grew an average of 5.6 percent a year. Investment picked up, poverty fell by 10 percentage points, and income distribution improved in two thirds of the countries.

But the global crisis has led to a dramatic slowdown in growth. This year the region is expected to post 3.5 percent growth, which is better than many parts of the world but falls short of historic trends.

With Latin American exports stagnating as the world’s developed economies continue to struggle, a stronger recovery in the developed countries would be welcome. The reality is, however, that the medium-term benefits that emerging economies could receive from faster growth in the United States are being swamped by short-term risks generated by the “capital tsunami,” as Brazilian President Dilma Rousseff has called it — or the “currency wars,” the termed coined three years ago by her finance minister, Guido Mantega.

The basic problem is the lack of a broader agenda that would make the Fed’s position consistent with that of Mantega and other emerging-country officials. That agenda must include two issues of global monetary reform that remain unaddressed: coordinated global regulation of capital flows in the short term, and a long-term shift toward a new international monetary system based on a true global reserve currency (possibly based on the International Monetary Fund’s Special Drawing Rights).

The European Union and the IMF are using capital flow restrictions to stem the banking crisis in Cyprus, and they supported similar measures in Iceland. But implementing these measures proactively across the board could help prevent these types of crises in the future. For example, the United States could benefit from such policies because capital-account regulation would force investors to find opportunities at home.

Meanwhile, a true global reserve currency would free the United States from concerns — and harsh rebukes — about the implications of its monetary policy on the global economy. At the same time, emerging markets would gain the full benefits of expansionary monetary policy in the United States, to the extent that it boosts demand for their exports.

Finance ministers and central bank governors throughout Latin America — which, aside from Brazil, now include Chile, Colombia, and Mexico — are already warning that today’s capital flood and the pressure to appreciate their currencies are pushing the region into a financial crisis that it has thus far been able to avoid. Without international monetary reforms, the global economy will continue to pressure emerging economies to become part of the problem.

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