19 September 2019
There will be no lifeboats if a premature Fed hike unleashes a global storm. Photo: YouTube
There will be no lifeboats if a premature Fed hike unleashes a global storm. Photo: YouTube

Why premature Fed hikes could cause global collateral damage

After 271,000 jobs were added last month, the US unemployment rate fell to 5 percent.

Meanwhile, average annual hourly earnings climbed by the most since 2009.

As a result, the US dollar strengthened and treasuries plunged.

The report was seen as a green light to raise interest rates for US Federal Reserve chairwoman Janet Yellen and her deputy, Stanley Fisher, who recently held out the possibility of an increase next month.

Nevertheless, US employment suffers from structural deceleration, which will force the Fed to normalize slowly and gradually.

Moreover, old tensions loom in the new labor markets.

While only 4.4 percent of whites were unemployed, the figure was higher for Latinos (6.3 percent) and blacks (9.2 percent).

After half a century of struggle for civil rights, black Americans remain twice as likely to be unemployed as whites.

The alternative employment figure, which includes both the jobless and part-time employed, is that 11 percent of the US labor force is without a steady job.

And the labor force participation rate remains at 62.4 percent — the same as in the 1970s.

The potential global impact of a premature rate hike looks even worse.

Dark history

Since the 1980s, the Fed’s monetary tightening has consistently reduced employment and output far more than the Fed anticipated, while causing huge collateral damage across the world.

In the early 1980s, the Fed’s then-chief, Paul Volcker, resorted to harsh tightening that devastated US households.

In much of Latin America, it resulted in a “lost decade” as growth plunged from 7 percent to -3 percent.

In the late 1980s, Alan Greenspan’s rate hikes undermined the struggling savings and loans associations, forcing Washington and state governments to bail out insolvent institutions.

In the early 1990s, Greenspan again tightened — but soon reversed his decision — which undermined expansion.

After his first tightening, global growth decelerated to less than 1 percent; after the second, growth plunged to 0 percent and then to -4 percent in developing countries.

In 2004-2007, Greenspan and Ben Bernanke tightened again, which led to the Great Recession, contagion from which spread across Europe and Japan.

In low-income economies, growth stayed at 5-7 percent, largely thanks to China’s growth and stimulus package.

Extraordinary global vulnerability

Today, however, the world economy is more fragile than it has been since World War II.

Despite cyclical recovery, Europe’s growth is sustained by zero-bound rates and quantitative easing.

In Japan, Abenomics has contained contraction but not stagnation.

As the Chinese economy is rebalancing, it cannot boost global growth in the way it did before.

India’s prospects have brightened in the Modi era, but growth remains below potential.

And while Russia suffers from the West’s misguided sanctions, Brazil’s contraction has worsened.

Premature rate hikes could fuel the US dollar’s sustained appreciation, which will contribute to external crises in emerging economies with soaring foreign currency debt and sharp exchange rate depreciations.

Since oil and commodities remain denominated in US dollars, a premature Fed hike may cause low-income resource producers to suffer a triple whammy — growth contraction, US dollar pressures, and a decline in exports.

Without traditional defenses

Internationally, the aftermath of the Great Recession has forced major central banks in the West to live with zero-bound interest rates.

Consequently, premature hikes will occur at a time when these banks lack most of their traditional defenses.

The Fed’s actions have global consequences, but it has no mandate for international accountability.

What the world desperately needs is truly global governance and a basket of multiple reserve currencies.

As China will soon host the G20 meetings and the International Monetary Fund will discuss the role of the renminbi as an international currency, change is in the air.

Meanwhile, misguided Fed decisions could contribute to a potentially huge storm, which we all must face without lifeboats.

For more of Dr Dan Steinbock’ articles, see

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Dr Dan Steinbock is the research director of international business at the India, China and America Institute (USA) and a visiting fellow at the Shanghai Institutes for International Studies (China) and at EU Center (Singapore).