- The Washington Times - Sunday, July 14, 2013

JACKSON HOLE, Wyo. — While the U.S. economy is healthy enough for the Federal Reserve to consider ending the extraordinary cash infusions it has pumped into world markets since 2008, such a change of course would pose big challenges for Europe’s debt-strapped economies and for many of the world’s developing countries.

Thanks to the Fed’s extraordinary ministrations, the U.S. economy has achieved “escape velocity” with solid job growth this year and is ready to be taken out of intensive care and recover on its own, said Paul McCulley, chairman of the Global Interdependence Center’s Global Society of Fellows, an economic group affiliated with the Philadelphia Federal Reserve Bank that held its annual economic conference last week.

“It has worked. My hat is off to the Fed” for nursing the economy through the “acute” stage of a monumental liquidity crisis that threatened to plunge the U.S. into a deep depression after the 2008 financial crisis, he said.

Under Chairman Ben S. Bernanke, the Fed for the first time experimented with trying to revive the financial markets and the economy in the aftermath of the crisis by purchasing more than $3 trillion worth of U.S. Treasury and mortgage bonds, forcing interest rates to record lows, which helped heal the economy but also created the conditions for a potentially destructive bubble in the bond market, he said.

The Fed, having achieved success, now is debating plans to move slowly and cautiously to end the $85 billion of bond purchases it has been making each month and gradually normalize the level of interest rates. Mr. Bernanke said last month that the central bank could start paring the purchases at any time, especially if the job market continues to improve. A growing number of Fed officials say they want to end the program this year.

Although the Fed’s move toward normalization signals a victory for the U.S. economy, financial markets around the world face major adjustments as the Fed slowly withholds and then withdraws the massive infusions of cash that have sent interest rates to unprecedented lows in the U.S. and in countries such as Turkey, South Africa and Brazil.

World markets react

The mere discussion last month by Mr. Bernanke and other top officials that the Fed may start phasing down bond purchases sent U.S. interest rates soaring by a full percentage point and set off tumult in world stock and bond markets. The brunt of the adjustment was felt by Europe’s weakest economies and emerging markets, where stocks plunged by 10 percent on average in the past month.

A substantial portion of the cash pumped out by the Fed in the past five years was invested in the emerging markets, Catherine Mann, a finance professor at Brandeis University, said at the conference.

“The influx of cheap dollars into emerging markets was not healthy. It overinflated Brazil and China made them grow too fast,” she said. “A lot of money went into Africa and the frontier markets” that are just starting to develop modern economies.

Now, these developing economies face the “challenge of trying to even out their business environment” while interest rates are rising sharply in reaction to the Fed and as their own economies are grappling with the recession in Europe and economic troubles elsewhere in he world, she said.

“Foreign capital will come back to the U.S. when the dollar appreciates and interest rates rise” in response to the Fed, she said. “It’s all coming home. That will be a good sign for the U.S. economy.”

But the transition will be much more difficult for emerging nations that depend on exports and “hot money” flows from the U.S. and other foreign investors to fuel investment and growth. They have not developed the kind of rich, consumer-led economy of the U.S., which can keep growing without outside help, she said.

“Without the ‘one night stand’ money” made available to investors by the Fed’s easy-money policies, she said, “it will be very challenging for an emerging market economy” in the months ahead.

Debt-stricken European countries such as Greece, Spain and Italy also are facing the hardships of significantly higher interest rates in the wake of the Fed’s plans, said Axel Weber, chairman of Swiss banking giant UBS.

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