Fed, Asia & Bailing Heavily Indebted Rich Countries

♠ Posted by Emmanuel in ,, at 10/18/2012 10:55:00 AM
A recent speech by this rather deplorable character Ben "Choplifter" Bernanke defends US monetary policy from its international critics by shifting the blame on them as frustrating global rebalancing. Quoth he:
In some emerging markets, policymakers have chosen to systematically resist currency appreciation as a means of promoting exports and domestic growth. However, the perceived benefits of currency management inevitably come with costs, including reduced monetary independence and the consequent susceptibility to imported inflation...

Under a flexible exchange-rate regime, a fully independent monetary policy, together with fiscal policy as needed, would be available to help counteract any adverse effects of currency appreciation on growth. The resultant rebalancing from external to domestic demand would not only preserve near-term growth in the emerging market economies while supporting recovery in the advanced economies, it would redound to everyone's benefit in the long run by putting the global economy on a more stable and sustainable path. 
Needless to say, I find his reasoning to be self-serving and unconvincing. But first, some history. You will of course remember the late-nineties to mid-noughties effort to (successfully) cancel the debts of Highly Indebted Poor Countries (HIPCs). The cause was championed far and wide, including by the Roman Catholic Church that made it a central feature of its Jubilee 2000 millennial advocacy. So far, thirty-four countries have availed of full debt relief from the likes of the IMF, World Bank, the Paris Club of sovereign lenders, and regional development lenders alike the African Development Bank (AfDB).

Nowadays of course, the world is (very reluctantly) extending financial help to yet more fiscally challenged nations, the Highly Indebted Rich Countries (HIRCs). Undeserving yet troubled European nations aside, the United States tops all comers of course with a historically unprecedented and rapidly growing public debt which amounts to almost $16.2 trillion last time I checked.

However, the international repercussions of American penury are more systemically serious for developing nations. Insofar as we still have not escaped the era of dollar dominance, the United States is still able to partly make other countries shoulder the costs of its Looney Tunes-style financial shenanigans combining unlimited megadeficit spending with ultra-loose cash. For most other open economies, for instance, holding ever more depreciating dollars is a cost that must be borne to maintain export competitiveness. It's not that they want to; it's that they still have to as part of playing the globalization game as capital flows head toward their shores in search of better returns than those offered by US dollars. Hence Brazilian Prime Minister Guido Mantega's notion of "international currency war" (though some dispute this idea like Ben).

It would of course be less of an injustice if only major LDC economies alike Brazil and China bore the brunt of American beggar-thy-neighbour strategies. However, it is also small nations that must put up with US actions. Take the Philippines. It is usually regarded as one of Asia's development laggards even if it has been described in more flattering terms as of late. That said, the Philippines is typical of other Asian nations which now have questionably large foreign exchange reserves. While bountiful reserves would have been welcome during the Asian financial crisis, nowadays it's just a waste of resources, most of which are in dollars. From p. 42 of the Philippine central bank's 2011 annual report:
In terms of currency composition, 75.2 percent of the total reserves (excluding gold) were denominated in US dollars; 15.3 percent were in yen; 3.8 percent were in euro; and the balance of 5.7 percent were in SDR and other currencies.
More recently, we received word that Philippines foreign exchange reserves have risen further to $81.88 billion for reasons no doubt familiar to LDCs:
The country’s foreign exchange reserves increased further to a new all-time high of $81.88 billion at the end of September as the central bank kept buying additional dollars from the market to prevent what could have been a sharper rise of the peso. In a report released Friday, the Bangko Sentral ng Pilipinas said the latest gross international reserves (GIR) were enough to cover for 11.8 months’ worth of the country’s imports and 6.5 times the combined debts to foreign creditors of private and government entities in the Philippines.

The BSP admitted that its foreign exchange operations, under which it trades currencies in a bid to prevent sharp and sudden fluctuations in the exchange rate, caused the GIR to shoot up...The Philippines and other emerging markets are attracting foreign “hot money” because of the crisis in the Europe and the anemic performance of the US economy. Problems confronting the advanced economies are driving portfolio funds to better-performing economies in Asia.
Precisely to cope with American-style ZIRP, I of course approve of LDCs like the Philippines having a managed currency float to smooth out volatilities introduced by certain others. Yes, it does involve open market operations in the form of buying dollars and selling Philippine pesos in this case if appreciation is too sharp. From Bernanke's rationalization, the Fed is merely helicopter-dropping dollars to fulfil its dual mandate--especially that of promoting full employment. Moreover, the Philippines would be one of those dastardly countries using monetary policy to frustrate international rebalancing by, among other things, preventing peso appreciation. However, Bernanke's reasoning is itself flawed. Consider:
  1. In the same speech, Bernanke says earlier that "As I have said many times, however, monetary policy is not a panacea";
  2. He continues by saying " the most effective approach would combine a range of economic policies and tackle longer-term fiscal and structural issues";
  3. Yet, in fact, ultra-loose American monetary policies have been complemented by massive deficit spending;
  4. Nor is it clear that these very costly "unconventional" measures have improved economic conditions Stateside as still-below-trend economic growth--1.3% in Q2--has supported only subpar job creation;
  5. Given the uniquely central position of the dollar in the world economy, the US still can still shower its trade partners with friendly fire (love that Choplifter analogy) by forcing them to pick up the slack from printing unlimited IOUs. 
Quite frankly, only the most gullible central bankers would render their countries vulnerable to this sort of American foul play. Remember too that these Yanks are precisely the same folks who advocated Washington Consensus-style policies to poor countries when they were in trouble, only to flout them when the US itself got into trouble. Prudent financial management? Getouttahere! In other words, it's always fine to make poor countries pay the costs of adjustment, but Americans will always refuse to do so.

The standard for reserve adequacy used to be for three months' worth of imports. With the Philippines' reserves approaching a year's worth of imports, think of almost nine months' worth of reserves as a subsidy to US profligacy--the world's most highly indebted rich country. While Bernanke refrains from commenting much on fiscal policy, you cannot ignore the complmentary role of both fiscal and monetary policy in describing the ill effects of US policy on the rest of the world. And again, they've burned through literally trillions and trillions of dollars from various creditors with nary an improvement in their fiscal or structural situation as Bernanke professes. Couldn't poor countries like the Philippines have used so much money wasted by those profligate Americans for far better and more developmental purposes?

Meanwhile, the Philippines has had one of the world's top six central bankers for two years in a row [1, 2] while Bernanke is not at all well-regarded in financial circles. I guess the "managed float" is not an odious practice as Bernanke implies, but rather his own monetary shenanigans in the eyes of central banking practitioners. The world economy has changed in some ways with the emergence of HIRCs, but not necessarily for the better. Unlike with HIPCs, there is no morally uplifting aspect to bailing out HIRCs.