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Fed taper and Emerging Markets: The G20 balancing act
February 26, 2014, 5:50 am

Can the G20 balance the demands of developed and emerging economies in the face of fed tapering to produce a coordinated growth target?

The two-day summit in Sydney of the G20 Finance ministers and central bankers has ended with a communiqué, which aims to increase the global growth target by 2% over the next 5 years. No detail on how this is to be achieved was agreed or released.  Talk of structural reform, which will lead to increased employment and investment, especially from the private sector has been discussed, yet for the emerging market economies of the G20, whose markets have been pounded of late due to the Federal Reserve’s tapering, the question remains; how can the G20 balance the competing demands of its emerging and developed members economies to achieve any form of coordinated growth?

 G20 Finance Ministers and Central Bank Governors pose for group photo after a closed-door conference in Sydney, Australia, on Feb.22, 2014 [Xinhua]

G20 Finance Ministers and Central Bank Governors pose for group photo after a closed-door conference in Sydney, Australia, on Feb.22, 2014 [Xinhua]

Australia’s Finance Minister, or Treasurer as he is called in Australia, was the host of the Sydney summit.  New to this position on the back of a change in government in Australia last September, Hockey made it clear that despite potential headwinds in the global economy, his outlook and therefore the agenda for the G20 Finance Ministers meeting would be positive and looking for growth, as opposed to the recent past which has focused on austerity and cost cutting.

The fact that no roadmap or concrete agreement on how the G20 might actually achieve this 2% growth target should not be viewed negatively, or as a failure of the summit.  On the contrary, it is positive, opening the door for collaboration and innovation between governments and the private sector.  It’s kind of like a PPP (public private partnership) on a global scale.

The elephant in the room is of course the Fed’s tapering of its quantitative easing program.  Much of the money that the Fed has pumped into the global economy in recent years has found its way into emerging markets, such as Russia, India, Brazil, Argentina and Indonesia, as investors are chasing higher returns in riskier asset classes, and the Fed’s tapering, or winding down of its QE program is seeing this money being withdrawn from these markets, with negative affects, such as falling stock prices, devaluating of currency, and less liquidity generally.

Joe Hockey and the G20 Finance ministers meetings have flagged the need for structural reform, in particular with regards to infrastructure investment.  Investment into infrastructure will provide jobs, improve efficiency in economies and promote long-term sustainable growth.

The Fed’s QE program provided none of this, because the flow of funds, particularly into emerging markets, was speculative in nature, rather than long term.  So when talk of Fed tapering hit the news wires as far back as May 2013, that speculative money began to exit emerging markets and headed back to developed markets. The result was stock market declines in EM markets matched by increases in developed markets, and currency devaluation in EM markets matched by increases in developed markets.  Again, none of this actually delivers economic growth; rather it is more like re-arranging the deck chairs on the titanic.  The potential for developed markets to “crash” is real, as the Fed tapering continues and the speculative money exits the investment scene all together.

Infrastructure investment, whilst less “sexy” than stock market speculation, is absolutely key to economic growth, and the funds need to come from the private sector predominately.  The role of the central banks should be to co-ordinate money flows in a sustainable fashion in order to provide a predictable and stable market base for investment, not be the actual source of funds for investment.  To encourage private sector investment into infrastructure, governments need to make some reforms, to entice the private sector into long term, sustainable growth assets.  The era of debt based financing is clearly coming to an end, evidenced by the Fed’s tapering, and is likely to be replaced by direct investment into productive assets: infrastructure.

Infrastructure investment has traditionally been seen as the responsibility of governments, as it is the engine, or springboard for economic growth.  Yet, in the modern global economy, where capital and commodity flows are rapidly changing from being centralized through central banks to a more networked direct peer to peer investment between consumers and producers, literally bypassing centralization, and central banks, a new infrastructure asset class will emerge, which is asset rather than debt based.

Finance ministers and central bank governors from  BRICS have called for the International Monetary Fund (IMF) to speed up their quota and governance reforms [Xinhua]

Finance ministers and central bank governors from BRICS have called for the International Monetary Fund (IMF) to speed up their quota and governance reforms [Xinhua]

Where will the money come from?  For countries, like Australia, who have a tidal wave of superannuation savings, and others, who have pension fund savings, the investment will in part come directly from these pools of capital.  Of course, governments of these countries, like Australia, will have to make reforms in how these funds are allowed to invest into these new infrastructure asset classes.  Given that these should be equity based rather than debt based asset classes, the burden on the tax system will be reduced, as it moves from public (government debt) to private (superannuation/pension funds).  It represents a move away from bank /government issued debt to direct investment into the productive asset, infrastructure.

The real test for the G20 will be if they can entice the trillions of dollars of capital, which currently hides in offshore and tax-free havens into infrastructure assets.  This will build the engine that will drive the bus of sustainable economic development globally.

Joe Hockey has no roadmap because there is no roadmap.  He is applying the great Australian pioneering spirit, the “can do” attitude which Australia has built a nation on.  He knows where we have to get to, and he knows there is no road there yet.  Building the road “is” the first piece of infrastructure investment.

As to the question of how does the G20 balance the competing demands of emerging market and developed market economies in the face of Fed tapering?  The risk now, lies much more with the developed economies rather than the emerging ones.  The bad news for the emerging economies is already out in the market, for the developed economies, it looks like it is yet to arrive.  To achieve a growth target of 2% developed economies are going to have to work just as hard as emerging ones, and the collaborative and positive spirit, which Joe Hockey is promulgating, has every chance of achieving this.


The views expressed in this article are the author's own and do not necessarily reflect the publisher's editorial policy.