Confused narrative

Good friend Harsh Gupta pointed me to the article penned by Dani Rodrik and Arvind Subramanian on the recent market turmoil faced by emerging economies (Turkey, South Africa, Brazil, etc.). They do not name names but they are referring to the comments made by the Turkish Prime Minister and that of Raghuram Rajan, the governor of the Reserve Bank of India. For a great point conveyed with telling deliberation and to great effect by Raghuram Rajan, see this short video.

There is always merit in making people see what they could have done correctly themselves but the points have to be cogent and coherent. Look at this paragraph and the next one:

The Fed has received scant word of thanks for propping up the U.S. and, hence, the world economy at a time when policy elsewhere (especially in Europe) was so counterproductive.

The next one:

The Fed may not be internalizing the objectives and constraints of other countries today, but neither did emerging markets act on the behalf of the Fed then. It isn’t convincing to cloak self-interest as unselfish cooperation.

So, in the first paragraph, the Federal Reserve saved the world and in the second paragraph, the Fed may not have internalised the objecives of other countries.

If the second statement is true, then the ‘Fed saving the world economy’ was incidental. The Federal Reserve was clearly acting in the interest of the US economy in 2008-09, 2011 and 2012 when it reduced interest rates to zero (0 to 0.25%) and then repeated QE2, QE3, not to mention ‘Operation Twist’.

In the G-20 meetings, the rest of the world – emerging economies in particular – was urged to increase their domestic spending so that the developed world could export their way out of trouble. Their domestic economies were broken. What have the leading emerging markets got for boosting current account deficits and spending? A run on their currencies mainly and in some cases, accompanied by run on their bonds and stocks.

Clearly, emerging economies were doing their part in running up current account deficits. The problem is the manner in which the current account deficits came about. That is a legitimate target of criticism but that is not what the authors criticise.

Instead, the authors criticise them for their financial globalisation. It is not unfair (deliberate use of double-negative) but it misses the point too. Yes, for instance, countries like India ran up fiscal deficits and in order to help corporations get their funding, the government liberalised external commercial borrowings. Corporations too, on their part, borrowed overseas heavily unmindful of possible risks – lack of foreign currency earnings, interest rate risk, Indian rupee weakness especially in the light of the inflation-laden fiscal policy that the government has been pursuing, etc.

These criticisms are fair but up to a point. If the argument is that these countries liberalised their capital accounts too much too soon, then that point should have been made more directly. ‘Financial globalisation’ is too vague and fails to carry the impact.

Were the authors afraid of the backlash they would get in their host country if they spoke up for capital controls?

Further, are emerging nations always free to choose to reject wholly or in part and also choose their timing of ‘financial globalisation’? Is the power balance between the United States and developing economies or emerging economies equal?

The US dollar is a global reserve currency but only the US can issue this fiat currency. The United States enjoys a lot of advantages of being the most dominant global reserve currency. That privilege comes with obligations whether M/S Rodrik and Subramanian agree or not.

Never in its history has the United States displayed any mindfulness of those obligations. It is not an ‘obligation to charity’. It is a quid pro quo for the enormous interest rate advantage that accrues to the US for the rest of the world accepting its fiat currency as their reserve currency.

Prof. Ron McKinnon has written extensively about the ‘Rules of the Game’ that were supposed to undergird this post-Bretton Wood dollar standard. The United States was expected to run a balanced fiscal policy and not be overly mindful of current account imbalances. The United States has failed in both.

When the current account deficit rises, it starts looking for scapegoats in the international community to blame. It deploys protectionist trade policies. It deploys rhetoric  against the so-called restrictive trade practices of other nations, both via friendly journalists, think-tanks and other outlets. The US knows but others pretend not to know that the charge of ‘restrictive trade practice’ cuts both ways and they happily play the blame-game on behalf of the United States.

Dr. Y.V. Reddy, the former Governor of the Reserve Bank of India brilliantly observed in his book that global financial markets (or, should we call them out more directly as ‘international financial institutions’?) do not treat emerging economies the same way they treat developed economies. Therefore, he said that it is symmetrical and rational for emerging economies not to treat financial markets the same way as developed economies treat them.

In a sense, that is what Raghuram Rajan said in his measured remarks delivered with great deliberation and to good effect. See link above.

In fact, given the ‘regulatory capture’ by financial institutions of policymakers in the developed world, sometimes the rest of us are hardpressed to distinguish genuine policy moves by developed nations from those aimed at benefiting their financial institutions.

So, what is the conclusion?

Developing countries did get their policies wrong to an extent. But, running up current account deficits is not one of them. The developed world wanted them to, but markets are now punishing them for it. They could have run up the current account deficit for the right reasons – domestic capital and infrastructure spending. But, that is an internal matter and does not alter the fact that they contributed to global demand which they were asked to do.

US acted in its self-interest as did developing economies. But, what the latter did was in line with the obligations enjoined upon them in G-20 meetings. What the US did was entirely for its own economy and it has not lived up to the commitments it made in those G-20 meetings in 2008-09.

There is an international power imbalance between Western and developing nations and hence, pacing or even avoiding ‘financial globalisation’ is not entirely in the hands of developing nations.

As the issuer of the global reserve currency, the United States has obligations to conduct monetary policy in a manner that is sensitive to global concerns. It is not an obligation to charity.

If it does not, other countries can choose to respond appropriately and that is exactly what Raghuram Rajan has said. That was not ‘playing the victim’ but a remarkable display of his grasp of realpolitik by warning them of the aces he has up his sleeve without showing them.

That was very well needed. M/S. Rodrik and Subramanian are off target by a wide margin.


9 thoughts on “Confused narrative

  1. George W. Bush was wrong to say that the U.S. does not need a “permission slip” from anyone in the world to act in its self-interest. Hindsight corroborates that greater caution in, or at least much broader multi-national support for, invading Iraq would have been better.

    However, I’m willing to wager that the Fed has even less of a need for a “permission slip” from anyone else to adjust its monetary policy.

    The reality is all monetary institutions have limited mandates (and a finite remit) and act in the national interest. Even monetary coordination, on the rare occasion that it has happened, is in the national interest! The argument that the Fed somehow has special responsibilities as the Dollar is the de facto reserve currency basically amounts to moral suasion (for greater monetary coordination) at best, and cannot for the foreseeable future be a hard-wired institutional reality
    I do accept that U.S. sovereign decisions have been notably selfish at times. They nixed the creation of a Japan-led Asian Monetary Fund, and the Congress recently has not acceded to even a limited cessation of voting rights to EMs at the IMF. But the US has also paid a price for its (and the IMF’s) actions in 1997-98. This is evident in the ‘never again’ mindset which led to massive reserve accumulation (and Greenspan’s ‘conundrum’), and the IMF to this day remains a bit of a pariah across most of East Asia.

    In the context of this debate what is interesting about RR is that he has smartly postponed RBI meetings to after Fed decisions. So, notwithstanding his warnings to the Fed to step up coordination efforts and all, in effect, RBI is already coordinating and India is doing the adjusting.

    Not sure what RR has in mind when he says the US/Fed had better watch out for the EM adjustment which is to come. The share of EM in global GDP is certainly rising and the transmission from EM adjustments to the developed world will certainly be felt. But once you take China out of the EM mix (and China has its problems, for sure), the heft and speed of convergence of the rest of the developing world is much less remarkable.

    Moreover, there is another reason why critics of US monetary policy are on slippery ground. In my mind at least, it doesn’t make much sense to condemn the QE experiment and then go on to criticize the scale or manner of its unwinding. This merely highlights an anti-Fed pathology.



    1. Your points are valid, esp. the last one. It is inconsistent to blame QE and then blame its withdrawal, on the face of it. That is why I believe there is more to it than what meets the eye. However, that does not mean that one cannot criticise the manner (or the speed and the magnitude) in which it was introduced and the manner in which it is being withdrawn. After all, two wrongs cannot make a right. That being said, the sooner the QE ends the better it is for the world, actually. It is so distortionary for everything. I am trying to get hold of Willem Buiter’s latest monthly from Citi. Apparently, he has written on this EM turmoil and the ‘obligations’ on the part of the Federal Reserve, etc.


    2. There is a far more balanced piece by Dani Rodrik (solo piece) in ‘Project Syndicate’ where he blames the problem more on financialisation of the world economy ( One answer is that emerging economies should raise walls and barriers when money comes flooding in. Will not make them popular among the financial types – analysts, investors and journalists nor will they be allowed to do so. Geopolitical power is not balanced. Second solution, as DR writes, is that emerging economies should ensure that the money flows to finance private investment in tradables sector. All correct. How will they do that, in practice, even if political economy in developing countries allows honest policymakers to try? Result? Booms and busts turning into crises in some cases.


  2. Response from Srinivas Thiruvadanthai (via email)

    Dear Ananth,

    Have you checked US trade surplus in services? Not too long ago, it used to be balanced. Now it is pretty solidly positive and expanding.


  3. Dear Srini,

    Yes, railing against Fed ‘tapering’ (hardly a tightening) is self-defeating. In fact, it goes against what Rajan has been writing about and talking about in the previous four years – on Fed policy.

    However, I think there is more than what meets the eye here – it is not just about Fed tapering. That the ‘new trade talks having more to do with finance and services could be one of the provocations.

    Yes, of course, I agree with you on the Asian Monetary Fund, on the fiscal dominance circumscrbing and limiting effectiveness of Indian monetary policy and central bank independence, etc.

    No arguments there.


  4. Response from Srinivas Thiruvadanthai via email:


    I think we agree on most things here. However, I think Fed policy is one of those things where the rest of the world should not be focusing its energies on. In my view, the main things to be challenged are:

    1) the new trade talks, which are hardly about trade but about more financialization and patents.

    2) IMF policies, which are very biased. In fact, if I am not mistaken the Washington trio were responsible for scuttling Japan’s proposal for Asian Monetary Fund, which would have made the Asian crisis far less severe.

    Under the current arrangement, EM face head I win tails you lose environment. if they run trade deficits, then sooner or later they face BOp crisis. On the other hand, if they run persistent current account surpluses, they are beholden to the vagaries of US consumer and capital goods demand. To break free from this situation, EM have to build institutions that are not beholden to US and European interests. But for that, EMs have to overcome their mutual distrust–a tall order.

    In the meantime, it is each man to himself–I dont think Rajan hectoring the Fed will have any impact whatsoever. It just highlights India’s weakness and deflects away from India’s real problems–poor infrastructure, massive corruption, the consequent inflation and poor competitiveness.

    Also, I think in developing countries, where the government bond markets are not well-developed and financial markets are relatively still thin, fiscal policy dominates monetary policy. If you have an out of control fiscal policy, I am not sure that an independent central bank will be able to target inflation a la the Fed. I know that Rajan cannot say that.

    last but not least, I think India and many other EMs need a course correction. Persuading the Fed to hold off on tightening will only prolong the unsustainable and delay the correction. BTW, if EMs weaken, it will blowback on Europe and eventually the US. Euope’s recovery has largely come because of improving current account–largely on account of EMs. And US trade have been a big boost to GDP over the past two quarters. So, they have much to lose from EM weakening. We will come a full circle. I think Rajan should welcome the Fed tightening!


  5. Dear Srini,

    Your points are valid, largely. Yes, EM electorates should constantly hold the feet of their power and policy elites to the fire. No questions.

    But, holding the ‘feet of the US to the fire’ is also important at least for realpolitik reasons. Therefore, in my mind, both are not mutually exclusive.

    Bout Swiss private banking system is also well exploited by American financial institutions. Almost all the big names have thriving private banks in Singapore and in Switzerland.

    As for your point that, after the US abandoned its commitment to the Bretton Woods, there was no pressure on the rest of the world to hold U.S. dollars is very eminently contestable. That is not my understanding at all. I would disagree very politely and very firmly too 🙂

    US flexes its muscles in more ways than one and there are layers of quid pro quo that advance the cause of financial globalisation and hence subject developing economies to the vagaries of capital flows.

    Even where fundamentals are good, countries have not been spared.

    As long as financialisation of the world economy remains intact and US policymakers are themselves, by and large, in thrall to the financial sector, one cannot and should not shield the US from blame either.

    It is legitimate to pursue sound policies internally and yet keep reminding the US of its obligations and of its limits in its pursuit of financial globalisation for the sake of its financial sector.


  6. Comments from Srinivas Thiruvadanthai via email:


    As long as EM politicians feel the need to hold Swiss Bank accounts you know that they themselves don’t trust their own system of government and laws. And the world will charge a premium to invest in EMs and run away at the first sign of trouble. Instead of blaming the Fed, we need to ask, why aren’t Australia and Norway blaming the Fed? None of them have reserve currencies. Why only the EMs? Ultimately EM elites are to blame and to the extent EM electorates let them get away with it, they too are to blame. I think we should use this opportunity to exert unrelenting pressure on EM elites. While we are at it, why don’t we ever censure the Swiss (or other banking havens)–they make the loot of the EM elites possible. After all, the US does not allow secret bank accounts. We need a international regime in which EM elites should run the real risk of lawsuit and prison terms when they travel abroad. EM elites have used anti-Americanism to cleverly deflect local anger from themselves.

    The Fed is ultimately responsible to the US Congress and therefore the US electorate. Since the abandoned the Bretton Woods, they didn’t ask the world to hold dollars. The fact is that the rest of the world has generally done a poor job of managing itself whenever the US has become isolationist.

    I don’t want to sound like a US apologist but in this case I think the majority of the blame lies elsewhere.


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