Stop Blaming the U.S. for Global Inflation

Leaders in emerging economies such as China and Brazil have accused the Federal Reserve of implementing policies that create inflation in their economies. They argue that low interest rates in the United States drive excess capital into their economies, increasing the prices of their goods and assets. This excess liquidity, they say, is causing inflation. While such complaints correctly identify the problem, these leaders misattribute the blame. Inflation is occurring and is the result of excess liquidity, but the monetary policies of emerging economies—not the U.S. Federal Reserve—are to blame.Why isn’t the Fed to blame? Because, as the saying goes, it takes two to tango. One country’s export must always be another country’s import. The central banks of emerging economies are voluntarily importing the inflation “produced” by the Fed. The general level of prices in an economy is determined entirely by the actions of its domestic central bank. Don’t be fooled by the complexities of monetary policy: a surefire way to combat inflation is to reduce the money supply. Simply put, the central banks in emerging economies need to print less money!Of course, this decision has its trade-offs. If emerging economies reduce their money supply it will cause their interest rates to rise, which in turn will make their assets more attractive and lead to an appreciation of their currencies. Emerging economies are not keen on this because their growth models are predicated on export-focused growth—they depend on demand in the developed world, and an appreciation would make their goods less affordable to consumers in these countries. In fact, the enormous growth of China, and of the Asian Tigers before it, would not have been possible without the consumer markets of the developed world, especially in the United States. The U.S. is known as the “importer of last resort” for a reason.For decades, the United States has filled this role because it was one of the few attractive places to invest and thus enjoyed large capital inflows. But times change. Owing to political and economic changes, economies outside the developed world are becoming more dynamic and, as a result, are becoming more attractive places to invest. In short, the United States now has competition and competition squeezes profits. The world in which the United States was able to borrow cheaply is fading away. Consequently, the United States will soon begin to save more and witness a shrinking of its capital account surplus. This is an inevitable change.However, this change has consequences. As the United States chooses to save more, imports will make up a smaller share of its economy. For countries dependent on exports—such as Brazil and China—this is a problem. In order to maintain exports, emerging economies are struggling to make their goods cheaper to U.S. consumers by keeping their exchange rates down. But this is a fight they cannot win. Efforts to hold down currencies eventually lead to rising prices (the effect emerging economies are trying to blame on the Federal Reserve) and rising domestic prices make goods more costly, thereby harming export competitiveness anyway. Baring a productivity explosion in the United States or a collapse in emerging markets, the U.S. will not have the demand needed to sustain so many export-led growth models. Emerging economies must develop their domestic consumer markets.Discussions of macroeconomic policy often become mired in complex and poorly understood terms like “rebalancing” and “quantitative easing,” but these issues often boil down to the straightforward concept of supply and demand. The markets in emerging economies, owing to financial repression on the part of their governments, are burgeoning with supply. At the same time, demand in the developed world is anemic. Something has to give. Policymakers in emerging economies should stop wasting their time trying to squeeze a few extra drops of demand from the United States and the rest of the developed world; they need to instead address the pent-up demand at home.The market is sending a clear message: a choice must be made. Emerging economies must either accept inflation or give up their export-focused growth policies and develop their domestic economies. By allowing exchange rates to appreciate and loosening their grip on financial markets, policymakers in the emerging markets can awaken their slumbering consumer markets. As the currencies of emerging economies appreciate, imports will become cheaper for consumers in these countries, thereby alleviating inflationary pressures. This change is fraught with challenges, but it is coming whether policymakers like it or not. It would be far better to prepare for these changes than to ignore them.