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The Federal Reserve: Scapegoat for Emerging Markets

After years of quantitative easing, and months of taper speculation, the central bank began paring monthly bond purchases by $10 billion in January, now at $65 billion. This decision enabled Former Federal Reserve Chairman Ben Bernanke to walk a fine line between hawks—finally giving them some reductions—and doves, who could hold on to the possibility of future increases should the US economy need ratcheted assistance.

Yet the Fed’s decision was met with much criticism abroad, as US stock market indices and emerging market currencies—particularly the South African rand and Turkish lira—tumbled. US markets fell sharply in January as investors retreated to Treasuries and fled emerging market funds in droves; while central bankers in India, Turkey, Brazil and South Africa, among others, resorted to raising interest rates reluctantly, in an effort to stabilize their plummeting currencies. But to appropriate this unease to the Fed is grossly misguided.

Last month, India central bank Governor Raghuram Rajan led the charge against the taper, claiming the Fed’s decision neglects developing nations: “We would like to live in a world where countries take into account the effect of their policies on other countries and do what is right, broadly, rather than what is just right given the circumstances of that country.” Overall, Rajan expressed his concern about a lack of cooperation among policy makers, and his belief that the US should “worry about the effects of its policies on the rest of the world.”

Given the fading glory days of the famously coined “BRICS” economies (Brazil, Russia, India, China, South Africa), a central banker’s disapproval from a country now in the Fragile Five (India, Turkey, South Africa, Brazil and Indonesia) is not surprising. Although Rajan believes emerging markets helped pull the global economy out of the crisis starting in late 2008, the vitality of emerging markets over the past few years has hinged largely upon the Fed’s easy money policies that helped finance their growth prospects and bloated current account deficits.

[pullquote]     Developing nations should use tapering as an opportunity to address important domestic challenges.[/pullquote]

The problems that caused emerging markets to suffer the most during this recent sell-off goes beyond tapering, and rests upon their own economic and political troubles. Rather than using the Fed as a scapegoat, struggling developing countries should focus on their faulty domestic policies. Currency weakness, tepid growth, high inflation, large fiscal deficits, bloated current-account deficits, and political instability and corruption—to name a few—are the real culprits plaguing the Fragile Five, in addition to Argentina, Russia, Ukraine, and several Central American countries. While the Fed may have pulled the trigger, the deep-rooted structural issues in many developing nations—not to mention the ominous slowdown of economic growth in China—are liable for the porous state of emerging markets.

Moreover, Rajan’s call for global monetary policy coordination is naïve and implausible. The US’s monetary policies must only account for domestic considerations, and factoring in other nations based upon their conditions at the expense of the US is not only foolish, but hurts everyone. The Federal Reserve’s dual mandate is to promote maximum employment and stable prices in the US, as supported by the Federal Reserve Act. Although Bernanke did not address emerging market turmoil during his January meeting, he stated at a press conference in September: “What we’re trying to do with our monetary policy here—as I think my colleagues in the emerging markets recognize—is trying to create a stronger U.S. economy…and a stronger U.S. economy is one of the most important things that could happen to help the economies of emerging markets.”

Federal Reserve Chairwoman Janet Yellen echoed Bernanke’s sentiment in her first report to Congress: the Fed’s policies target domestic economic objectives, and although other countries will naturally bear some spillover, all the Fed can do is be clear about its intentions. Further, she said that emerging markets “do not pose a substantial risk to the U.S. economic outlook,” and she does not believe the Fed is at fault for recent volatility.

Janet Yellen

In stark contrast to Alan Greenspan, Yellen could not be clearer about her monetary policy intentions as Fed Chairwoman, which closely resemble Bernanke’s approach. Yellen’s continuity and devotion to weathering the US’s economic woes is promising, as reflected by the stock market’s positive reaction to her comments before Congress. The role of the Federal Reserve Chair is to serve US interests first and foremost, which will ultimately best serve the rest of the world.

Mexico’s Finance Minister Luis Videgaray understands that tapering will help developing nations in the long run. During an interview on Bloomberg this week, Videgaray affirmed tapering as a positive sign because it means that the US is growing again, which in turn, means the Mexican economy is growing due to how closely both markets are connected.

While emerging markets are arguably not in the midst of a crisis, certain developing nations remain extremely vulnerable due to internal problems and an overreliance on foreign investment. Many emerging markets became too dependent on liquidity provided by the US, and they are paying for it. To continue artificially propping up dependent emerging markets—when it is not in the best interest of the US—is not only a disservice to the US, but also to those weak economies because of its unsustainability. Developing nations, like India, should use the tapering as an opportunity to address their domestic challenges in an effort to become more independent and robust, economically and politically.