Tyler Cowen has a new post discussing the financial strains in developing Asia. At the end he suggests that some of their problems are due to expectations that the Fed will taper QE. I doubt that plays much of a role, but would acknowledge that the alternative explanations are not very appealing either. When the picture is this muddled, it almost always suggests that more than one factor is involved.
So what’s wrong with the tapering explanation of Indonesia’s problems? Tyler even suggests that it fits the market monetarist methodology—market indicators suggest tapering is the problem.
Maybe they do, but it’s also the case that market indicators fit another explanation just as well—Indonesia is being hurt by expectations of stronger growth in the US, in much the same way that America’s 1929 boom caused problems for the rest of the world (via higher interest rates.) The question is not why is the Indonesian stock market down 21 percent. The real mystery is why are US stocks higher than when the taper talk began? Perhaps they should also be down 21 percent. Long term real interest rates have risen sharply in recent months. That should cause a stock market crash, unless the higher rates are caused by something that would also raise equity prices. And what might that be? Obviously stronger real growth in America is one possibility (although there are others as well.)
However Evan Soltas showed that although US stocks have done well in recent months, they’ve tended to fall on days where taper talk raised long term yields. OK, but that implies that the mysterious X-factor driving up US stock prices is even stronger than we thought, as it’s also had to overcome the negative effect of taper talk. And I admit that I just don’t see the signs of stronger economic growth. But then what’s going on with US equity markets?
I’d encourage everyone to take a deep breath and let’s wait 12 to 18 months, by which time it may be easier to see what’s going on right now. Here are some other issues to consider:
1. The article Tyler links to implies that Indonesia’s being hit by an adverse supply shock (lower RGDP growth and higher inflation.) But the numbers provided suggest the shock is mild, at least so far. Could this be the China slowdown hitting Indonesian commodity exports? Australia has recently been hit by this shock. Or are higher real interest rates reducing investment in Indonesia, and hence forcing “re-allocation?” This is where QE tapering could hurt Indonesia.
2. Why blame QE? If the mechanism is higher real interest rates caused by changing conditions in US credit markets, then it’s the exact same mechanism as in the late 1990s, when the US high tech boom made things difficult for many developing countries.
In other words, some countries may be more sensitive to volatility in global real interest rates than other countries. And again, if QE were causing that volatility then US equity prices should be reflecting that fact. But with a few exceptions they are not.
Here’s another way of making the same point. Write down on a piece of paper a monetary rule that makes real interest rates less volatile than NGDPLT. Can’t do so? Neither can I. That means that monetary policy actions by the Fed that are aimed at stabilizing NGDP, do not obviously make US real interest rates more volatile, and hence can’t be blamed for hurting fragile economies that are sensitive to real rate shocks. In that case tapering may be a problem, but only because it destabilizes NGDP. In that case the Fed is erring not because rates are rising, but because NGDP growth would be slowing.
Just to be clear, I’m not saying that higher global real interest rates that are caused by changing conditions in US credit markets cannot hurt Indonesia. They can, just as higher global oil prices caused by Chinese factors hurt the US in mid-2008. But if someone said that the higher Chinese oil prices were caused by less Chinese oil supply, and not more Chinese demand for oil, a skeptic would ask why Chinese consumption of oil had increased. And if someone claims that higher global real interest rates are caused by tighter money in the US, and not stronger RGDP growth expectations in the US, a skeptic will ask why US equity prices are much higher than a few months back.
I am skeptical of my own analysis here, as I just don’t see the faster growth that stock investors seem to see. But I’m also skeptical of alternative explanations. We need to let the dust settle to figure out what’s going on here.
PS. Did the Indonesian central bank take advantage of QE by allowing faster NGDP growth? If so, then they arguably contributed to the current instability.
HT: CA