THE IMF KNOWS THAT THE FED IS PLAYING WITH FIRE IN EMERGING MARKETS / THE TELEGRAPH

The IMF knows that the Fed is playing with fire in emerging markets

By Ambrose Evans-Pritchard Economics     

Last updated: September 9th, 2013

    

Photo: Reuters

Listen to the IMF's Christine Lagarde very carefully. While the US Federal Reserve has as a parochial "closed economy" view – and made a series of grave blunders over the last six years as a result – her job is to look at the entire world, and she does not like what she sees.

She warned over the weekend that Fed tapering could ricochet back into the US economy if handled carelessly.

"Very negative spillover effects on the emerging market economies could very much backfire on other economies. So to assume that the domestic economy is totally isolated, that a country is an island, would not be the right approach," she told CNBC at the Ambrosetti Forum on Lake Como, which I have been attending.

"Without necessarily changing the mandate, without reviewing the terms of references, and maybe without even acknowledging it, I cannot believe that central bankers do not take into account what's happening elsewhere in the world," she said.

Unfortunately, that is exactly what the Fed seems poised to do. It is an open question whether the US economy itself has really reached escape velocity, or is strong enough to withstand much tapering, and the European economy is not even close to that point.

One suspects that the Fed is acting for "bad motives" rather than "good motives", by which I mean that it is starting to tighten because of growing (and understandable) alarm about speculative excess, or because the Fed is worried as an institution that it cannot easily extract itself from QE if it waits until 2014 (the Mishkin thesis), not because the US economy is genuinely healthy.

But the Brics are in no fit state to cope with the withdrawal of global dollar liquidity. And remember, emerging markets now make up half the world economy, so we are in uncharted waters here.

Of course, one might say the Brics deserve to be taken down a peg or two, since they seem determined to collude in Assad's chemical weapons attack, blocking any punitive measure at the UN (and there are measures short of missile strikes). Why is India taking this squalid position? Why is Brazil? Why are they allying themselves with the dictator Putin, now the full accomplice in a terrible crime?

Why are they continuing to show such lack of leadership, such an inferiority complex? Why for that matter is Germany – which started the ball rolling with Mustard gas in 1915, and therefore should have a special responsibility – so unwilling to go along EU partners in any way? Why is it doing so little to muster proper condemnation? Frankly, I am shocked by Germany's behaviour, since it appears to have no moral content at all.

So if the Brics come pleading for mercy as Fed tapering sets off a faster pace of capital flight, they cannot expect a very friendly response from Washington.

Be that as it may, any satisfaction that the US may enjoy from seeing the Brics humbled a little will not last long if the effects spread contagion to southern Europe again, and then back into the US economy itself.

The IMF is right, but is anybody listening at the Fed?