[Viewpoint] A trade-off is needed on currencyGlobal growth is likely to remain subdued over the next few years, with industrial countries struggling to repair household and government balance sheets, and emerging markets weaning themselves off of industrial-country demand.
As this cleanup from the Great Recession continues, one thing is clear: the source of global demand in the future will be the billions of consumers in Africa, China and India. But it will take time to activate that demand, for what is now being produced around the world for industrial-country consumers cannot simply be shipped to emerging-market consumers, especially the poorer ones among them.
If we want to talk about billions of new consumers, rather than the tens of millions who have incomes similar to the middle classes in industrial countries, we must recognize that many emerging-market consumers have much lower incomes than industrial-country consumers, and live in vastly different conditions. Their needs are different, and producers around the world have, until recently, largely ignored them.
But times are changing. Increasingly, producers are focusing on people who, if not at the bottom of the income pyramid, comprise the vast numbers nearer to the base.
For example, an Indian company, Godrej, is making an innovative refrigerator targeted at poor villagers. Village women typically are forced to cook multiple times during the day because the food that they prepare in the morning spoils in the heat. They would like to be able to refrigerate uneaten food, which would limit waste as well as time spent cooking. Unfortunately, with electricity supply intermittent even when available, compressor-based electric refrigerators, which consume a lot of power, have not been an option.
Godrej’s engineers observed that if the objective was only to keep food from spoiling, and not necessarily to make ice, it would be sufficient if the refrigerator cooled to a few degrees above zero centigrade (32 degrees Fahrenheit). This would allow the use of a less power-hungry fan instead of a compressor, and the fan could run on batteries rather than relying on the power grid.
This is the kind of frugally engineered product that can create enormous new consumer demand in emerging markets. Companies in the industrial world are taking note. General Electric, for example, is cutting down the functions provided by its medical equipment to only what is strictly useful in order to supply remote rural clinics across the developing world. “Just-enough” functionality makes the equipment affordable without compromising quality.
Over the next decade, growth in this kind of developing-country demand will help offset the slow growth of demand in industrial countries. But the process cannot be rushed. Unfortunately, with high levels of unemployment in industrial countries, policy makers want to do something - anything - to increase growth fast. The aggressive policies that they are following, however, could jeopardize the process of adjustment.
Consider the United States Federal Reserve’s foray into quantitative easing. Clearly, the Fed’s objective is to increase bond prices, in the hope that lower long-term interest rates will propel corporate investment. In addition, the Fed hopes that lower long-term interest rates will push up asset prices, giving households more wealth and greater incentive to spend. Finally, by demonstrating a willingness to print money, the Fed hopes to increase inflationary expectations from their current low levels.
Even though the markets seem to be anticipating substantial levels of quantitative easing, U.S. corporate investment remains subdued. And U.S. households seem wary of splurging again as they did in the past, no matter how wealthy they feel.
The Fed has, however, succeeded in enhancing expectations of inflation in the U.S. With its anticipated bond purchases keeping a lid on interest rates, the net effect is that investors do not see an adequate real return from holding dollar assets, which is perhaps one reason the dollar has been depreciating.
Emerging markets are worried because they believe that the Fed’s ultra-aggressive monetary policy will have little effect in expanding U.S. domestic demand. Instead, it will shift demand towards U.S. producers, much as direct foreign-exchange intervention would. In other words, quantitative easing seems to be as effective a method of depreciating the dollar as selling it in currency markets would be.
Because they know that it will take time for domestic demand to pick up, emerging markets are unwilling to risk a collapse in exports to the U.S. by allowing their currencies to strengthen against the dollar too quickly. They are resisting appreciation through foreign-exchange intervention and capital controls. As a result, we might not see steady growth of demand in emerging markets. Instead, excess liquidity and fresh asset bubbles could emerge in the world’s financial and housing markets, impeding, if not torpedoing, growth.
In the ongoing showdown over currencies, who will blink first? The U.S. (and other industrial countries) could argue that it has high levels of unemployment and should be free to adopt policies that boost growth, even at the expense of growth in emerging markets. These countries, in turn, could argue that even very poor U.S. households are much better off than the average emerging-market household.
Rather than bickering about who has the stronger case, it would be better if all sides compromised - if everyone blinked simultaneously. The U.S. should dial back its aggressive monetary policy and focus on repairing its own economy’s structural problems, while emerging markets should respond by allowing their exchange rates to appreciate steadily, thereby facilitating the growth of domestic demand. Is it too much to hope that the G-20 can achieve such a commonsensical compromise?
*The writer is a professor of finance at the Booth School of Business, University of Chicago.
by Raghuram Rajan