For Emerging Economies, Rising Global Influence

Friday, 15 October 2010 12:48 By Paul Krugman, Krugman & Co. | Op-Ed | name.

Thanks to bad policies and bad ideas, the world’s advanced economies seem set to experience a prolonged period — maybe even a lost decade — of weak growth, high unemployment and low interest rates.

Emerging economies, such as Brazil’s, have been doing much better, in part because they inherently offer bigger investment opportunities. Also, they don’t have the balance-sheet problems of richer nations. Emerging markets have been building up reserves while avoiding foreign-currency debt, so they have addressed many of their past vulnerabilities.

(Image: Cummings / Winnipeg Free Press - Winnipeg, Canada / Provider: CartoonArts International / The New York Times Syndicate)

So what should we expect now?

Let’s look at real effective exchange rates as an indicator — they reflect average rates for a currency relative to an index of other currencies, adjusted for inflation. On this page is a picture of Brazil’s exchange rates starting in January 2007 — roughly the point where economic bubbles began to deflate in earnest.

(Source: International Monetray Fund and the Central Bank of Brazil / The New York Times)

China’s rates have, of course, gone nowhere, but if we use them as a point of reference, we can see that Brazil endured a brief period of sharp decline in its exchange rates, coinciding with the post-Lehman oh-God-we-are-going-to-die period when everyone wanted nothing but United States bonds. But beyond that, Brazil has seen a big increase in its currency’s buying power.

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By now, everyone is aware that the world’s advanced economies have suffered a large negative-demand shock, probably a highly persistent one, which has pushed them into liquidity-trap territory. This means investors in those nations can expect low interest rates and low investment returns, hence large capital flows to developing countries like Brazil, which haven’t suffered a comparable shock. But now the question is this: Should countries such as Brazil worry about the exchange rate appreciation that is now affecting their economies? As I see it, there are two ways it could be problematic.

First, exchange rate appreciation leads to decreased demand and thus a larger current account deficit — an imbalance which happens when imports exceed exports, creating debt for that nation. Up to a point, this can be offset by cutting domestic interest rates. But if the contractionary effect is big enough, it can push emerging markets into their own liquidity traps. In effect, the 33 nations within the Organization for Economic Cooperation and Development can export a liquidity trap to the developing world via capital flows.

Second, we can have another “global savings glut” — this is a term that comes from a 2005 speech given by Ben S. Bernanke, chairman of the Federal Reserve. Along with my wife, Robin Wells, I have argued that the savings glut was driven largely by developing-country surpluses and was probably the main initial driver of the housing bubble in the North Atlantic.

In a September piece in The New York Review of Books, we explained that developing countries have in the past run trade deficits with advanced economies through the purchase of goods needed to spark economic development, such as machinery. In the 1990s, though, some developing economies ran large trade surpluses with rich countries to accumulate foreign assets as insurance against a financial crisis. So as countries bought huge amounts of bonds and assets from nations like the United States, Britain and Spain, it meant large inflows of capital.

This drove down longer-term interest rates in the United States and European nations.

In turn, housing prices rose much more than they should have, and thus led to a bubble.

Might a new version of the global savings glut, driven by depressed demand in the north, produce comparable trouble in developing countries?

It is food for thought. 

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Backstory: A Seat at the Table

Some European member nations and the United States have expressed concerns that developing countries have engaged in what U.S. Treasury Secretary Timothy F. Geithner calls “competitive devaluation” of their currencies, which could lead to unfair trade advantages and to asset bubbles. At recent International Monetary Fund meetings, this is one of the most contentious topics of discussion.

Countries such as Brazil have said they do not want to be forced to raise the value of their currencies in order to pay for the financial crisis, which primarily affects rich nations. Henrique Meirelles, Brazil’s central bank president, told Reuters on Oct. 1 that nations are merely trying to protect their economies by weakening their currencies: “We cannot simply allow our economies to be imbalanced while allowing other economies to be balanced.”

So, as the world’s advanced economies have been trying to recover from the global economic downturn, developing nations such as Brazil and India have indeed gained a great deal of financial clout in the markets.

But now they want more of a say at the International Monetary Fund, which is based in Washington. They contend that the European Union takes up too much space at the I.M.F’s bargaining table, where the global financial system is overseen based on the economic policies of its members.

Europe contributes 20 percent to global gross domestic product, yet controls a third of the votes at the I.M.F and nine of the executive board’s 24 seats. Since August the I.M.F. has been debating how best to reallocate board seats to make room for countries that are less economically advanced.

The United States, which holds veto power at the I.M.F., is considering negotiating with the Europeans to reorganize the board, or else it will eliminate four seats.

Ironically, one of the four chairs likely to be eliminated is held by Brazil.

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Paul Krugman joined The New York Times in 1999 as a columnist on the Op-Ed page and continues as a professor of economics and international affairs at Princeton University. He was awarded the Nobel in economic science in 2008.

Mr Krugman is the author or editor of 20 books and more than 200 papers in professional journals and edited volumes, including "The Return of Depression Economics" (2008) and "The Conscience of a Liberal" (2007).

Truthout has licensed this content. It may not be reproduced by any other source and is not covered by our Creative Commons license.

Paul Krugman joined The New York Times in 1999 as a columnist on the Op-Ed page and continues as a professor of economics and international affairs at Princeton University. He was awarded the Nobel in economic science in 2008.

Mr Krugman is the author or editor of 20 books and more than 200 papers in professional journals and edited volumes, including "The Return of Depression Economics" (2008) and "The Conscience of a Liberal" (2007).

Copyright 2010 The New York Times Company.

Last modified on Friday, 15 October 2010 14:54