Over the last few months the Fed was planning a possible September taper in an effort to begin unwinding the quantitative easing that has been pumping fresh money into the markets. Now, its not working out quite how they planned because its creating a crisis in emerging markets and now the threat of military action in Syria will intensify the downward spiral.
By Matthew Lynn
Aug. 28, 2013, 5:01 a.m. EDT
LONDON (MarketWatch) — The script was all set for the rest of the 2013. Come the autumn, the Federal Reserve would slowly start to unwind the quantitative easing that has been pumping fresh money into the markets. Bond yields would start to slowly rise. The economy might stutter, but it would prove strong enough to take that in its stride — and slowly monetary policy would begin getting back to normal.
The trouble is, the story is not working out the way it was meant to. Already the threat of an end to QE in the U.S. had started to create a crisis in the emerging markets. Now the threat of military action in Syria will intensify the downward spiral. That is going to spread to Europe next. It is already lapping at the shores of the continent’s peripheral countries.
As the turmoil grows worse, it will stop global growth in its tracks. And the net result? The Fed will carry on printing money longer than it planned to. It won’t have any other choice.
All through last week, the emerging markets were starting to wobble. India looked to be entering a full-blown financial crisis. The rupee USDINR +0.73% had plunged in value, and stocks were getting hammered. Far from turning into an economic superpower — as it was supposed to be when the BRICs were all the rage — it is looking more and more like a basket case. Growth has slowed, inflation is rising, and the government has become hooked on massive deficits. Capital is starting to flee the country.
Brazil was not in much better shape. Last week, its central bank had to throw $60 billion at shoring up the currency USDBRL -1.03% after it dropped to a five-year low against the dollar.
The crisis is starting to spread to other major markets as well. Turkey has already been through a political rebellion this year, and now there is economic upheaval as well. The Turkish lira USDTRY +0.50% is in free fall, and 10-year bond yields last week jumped above 10%. Indonesian stocks ID:JAKIDX +1.48% dropped 5% in a single session, and have plunged to 2013 lows. Investors have taken fright, and, after years of piling into emerging markets, are heading for the exit.
Now there is the prospect of military intervention by the U.S. and Britain in the civil war in Syria. The use of chemical weapons leaves the major powers with relatively little choice: if they accept that brutal regimes can gas their own people to stay in power then their use will become widespread.
They will be encouraged by the limited intervention in Libya — a small air war topped the old regime, and cost little in either money or lives.
The trouble is, it comes at a bad time for the markets. An intervention in Syria will threaten to convulse the Middle East and send oil prices CLV3 +0.92% soaring upwards. It will make nervous investors even more skittish. If the Russians insist on backing the Assad regime to the bitter end, it may still have the potential to turn into an even-more-serious conflict than anyone yet reckons on.
So far, so what? Newly developing economies have always been volatile, and after more than a decade of stability and growth were due a selloff. The civil war in Syria has been rumbling on for months now and the end game was always going to be nasty — and it was always unlikely the West could remain completely uninvolved. No one can claim to be very surprised that either has suddenly blown up.
The trouble is, both the emerging-markets crisis and the Syrian conflict have two big consequences for the rest of the global economy.
The first is that these countries are far more important than they used to be. The world has not seen a genuine crisis in the emerging markets since the Asian financial collapse of the 1990s. They have been on a steady path of development since then.
The result of more than a decade of uninterrupted growth is that they are far wealthier and account for a far greater share of global trade than ever before. Roughly 50% of the world economy is now accounted for by the emerging markets. Back in the 1990s, if growth in those economies collapsed, then its impact might well be contained. Now it threatens to plunge the world back into recession.
The second is that much of the euro zone is now, in effect, an emerging market.
The peripheral nations of the Europe — Greece, Cyprus, Italy, Spain, Portugal and Ireland — have many of the same characteristics as nations such as Thailand and Malaysia back in the 1990s. They have huge borrowings in what is in effect a foreign currency — the euro EURUSD -0.51% , over which they have no control. Capital is likely to flee at the first sign of serious trouble. They don’t have the ability to print their own currency, or to devalue their way out of trouble.
If the emerging-markets crisis spreads, and if a military intervention in Syria pushes up the price of oil, then the euro zone will be pushed back into recession as well. Very quickly, 70% of more of the global economy could have ground to a halt.
Where does that leave the Fed? In a fix. In reality, the U.S. cannot simply shrug aside an emerging-market crisis or a conflict in the Middle East as a matter of little consequence. Its own growth depends on trade with those nations, and so does the stability of its banking system. With no expansion in those markets, U.S. growth will evaporate, and with it the case for the taper.
The lesson of Japan is that it is a lot easier to start quantitative easing than it is to stop it. The Federal Reserve is about to learn that as well. Over the next few weeks, the “Septaper” will be quietly shelved. It may try to end QE in February or March next year — but by then, some fresh crisis may have flared up to blow it off course.
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