When the World’s Sugar Daddy Turns Sour
Is the U.S. about to send the global economy into a tailspin?
The president of the United States is in Africa. Nelson Mandela is on life support. John Kerry is in Israel. Syria festers. America is somehow shocked that its plan to rely on the goodwill of the Taliban and Hamid Karzai to solve Afghanistan’s problems isn’t working. Edward Snowden seems to have spent the past week playing in the Moscow road company version of the Tom Hanks movie The Terminal.
Yet somehow, in my mind’s ear, I hear the ominous music that normally accompanies the approach of an animatronic shark, suggesting there is a bigger story out there — one whose dorsal fin broke the surface in the past few days, one that is slowly circling us.
You saw hints of the story in the financial markets as they slipped and stumbled from Shanghai to Lower Manhattan. You have seen other elements of it in the streets of Istanbul and Rio. You heard it alluded to in the words of U.S. Federal Reserve Chairman Ben Bernanke. Almost simultaneously, you saw it in the actions of Chinese officials cracking down on the loose credit policies that had created an asset bubble in their underregulated, lend-first-ask-questions-later world of shadow banks.
Yes, the big story of 2013 — and likely 2014 and 2015 — is also the big story of 2008 and 2009: the financial crisis, which is far from over. When I talk to current and former Obama administration officials who had responsibility for responding to the financial crisis, they do credit the Bush administration’s comparatively swift and politically courageous steps with slowing the free-fall of 2009, but they argue that two-thirds of the most important steps were taken in the months after Obama became president. It is not just pride that leads them to this conclusion — fiscal and monetary heavy-lifting during those days certainly kept America from spiraling into another Great Depression. (Doubt it? Look at the results in Europe, where such decisive action was not forthcoming.)
But, while these old hands are right that historians will one day conclude that the bulk of the steps required to manage the crisis took place in the Obama years, they are wrong about one thing. Many of the most decisive measures won’t be seen to have happened in 2009 or 2010. In fact, they haven’t happened yet. And the past week is proof of that.
That is because almost certainly the most critical step taken to keep markets from cratering during the crisis and to help them recover thereafter — the decision to pump the global economy full of stimulus dollars — has yet to fully play out. We have seen the benefits of pumping $10 trillion into economies worldwide, of making money easily available, of wrestling interest rates to the floor and holding them down. But we have yet to see how draining that warm economic bubble bath from our tubs is going to make us feel and what it leaves exposed.
Bernanke made a conscious decision to start preparing the markets for this next phase months ago, when he announced that once the U.S. jobless rate hits 6.5 percent, the Fed will begin tightening its money policies again. Then, last week, he suggested that the tripwire might be 7 percent and that the Fed might start winding down its $85 billion-a-month bond-buying spree sooner than expected. Investors, behaving like "feral hogs" in the colorful words of the smart Dallas Fed chief Richard Fisher, detected "a bad scent" and went after it, pressing markets to price in interest-rate hikes well earlier and higher than those the Fed meant to suggest were coming.
Meanwhile, in China, authorities were making less credit available in an effort to let some of the air out of the bubble in Chinese banking, which has been fueled by the aggressive practices of the shadow banks. This spooked Asian markets and later world markets, which were already uneasy because of Bernanke’s comments, and the results were big stock market losses, bond market turmoil, and jitters that remain through today.
But this past week’s tremors only hint at the problems to come. These problems take several forms. The first is purely economic — the consequence of reversing the stimulus. Taking $10 trillion out of the economy will inevitably force up interest rates and, if not timed properly, could easily derail fragile recoveries. (Indeed, if Bernanke, who has managed much of this crisis masterfully, misplays this last phase, his repeated signaling of a coming turn in policy will rank right up there with Bush’s "mission accomplished" in the pantheon of premature declarations of success.)
The United States, where a recovery seems to be gaining steam and the economy is fundamentally strong, might be able to withstand a little bad timing or market skittishness. But other economies — economies that have benefited from the unprecedented global stimulus that was led by the Fed and the accompanying coordinated weakening of the major global currencies — might be much more vulnerable to such missteps. Places like Turkey, Brazil, and Indonesia, not to mention weaker emerging markets, could feel the pinch more severely. Investors are already wondering aloud how much of their recent success has been a stimulus-fed sugar high. And because those countries are just now on the way up, still home to real inequality and unresolved structural challenges, the political consequences of the coming shift in global economic momentum could be quite serious. The political fragility in Turkey and Brazil, whose recent protests have important economic drivers (as did, of course, the Arab Spring uprisings), suggests how ominous this development could be. That reversal of the stimulus policies could negatively impact global commodity prices (as demand slows) will only compound the problem in emerging economies that depend on resource exports.
Of course, the most important emerging economy is China’s. The government there has begun — with remarkable swiftness for a new regime — to dial back its irrational-exuberance-with-Chinese-characteristics. But should it move too quickly or not quickly enough and/or should U.S. tightening increase pressure on the economy (as there are fewer dollars in the system to invest in potentially risky places like China), one of China’s several internal economic bubbles (banking, real estate, etc.) could burst. The resulting disorder could, in turn, spook global markets and particularly hurt emerging economies. And, again, economic crunches often produce political unrest. If that unrest were among disgruntled Chinese citizens in Chinese streets, it would have repercussions far beyond the borders of China. Indeed, a "Chinese Spring" would instantly be the biggest story in the world, a potentially epochal game-changer that would have the planet holding its breath. While Egyptian- or Turkish-style unrest may not seem imminent in China, President Xi Jinping seems to be conscious of the stakes, and his policies — like those of Brazil’s President Dilma Rousseff — suggest that he recognizes the need to address popular complaints about corruption, cronyism, and enduring inequities.
Nonetheless, even with enlightened leaders, the international system has not evolved to the point that there are anything but informal mechanisms to help coordinate such a massive policy shift. We may all be in the same worldwide economic boat and leaders may be in touch with each other more than ever before, but domestic factors drive how monetary policies like these will play out, and therefore the possibility of misalignments is real.
In other words, change is on the horizon — change that could have economic and political consequences that touch every corner of the world. How the current crop of international leaders manages it will likely determine how history judges them. And the degree to which they realize that they are dependent on one another may be the decisive factor in their success or failure. That may be why I can’t get that damn shark music out of my head.