US unemployment ‘result of people giving up’; emerging markets ‘little’ exposed, says economist

Transcript

It’s only a matter of time before US interest rates, which have been at a historical low, rise. But with unemployment figures better than expected, the government will raise rates sooner. So what does this mean for emerging economies? World Finance speaks to Jerome Booth, economist and leading expert on emerging markets, to hear his views.

World Finance: Well Jerome, unemployment’s link to rates rises: how useful a mechanism is this for stimulating economies?

Jerome Booth: There’s a lot of misunderstanding about what’s going on in the US! There are still about 45 million people in the US on food stamps, and that hasn’t gone down significantly since the height of the crisis.

So the unemployment numbers are actually a result of people giving up and not being part of those numbers.

[T]he unemployment numbers are actually a result of people giving up and not being part of
those numbers

The actual underemployment in the US is pretty much as high as it was. It’s improved slightly, but it’s still very high.

I think there’s also a misconception about the objective of quantitative easing, and the trajectory of interest rates, and the separation of those issues and tapering.

Quantitative easing was a policy in the absence of the fiscal authority seizing banks, whereby the central bank wanted to avoid depression. To avoid that, you have to have the banks healthy. So quantitative easing was a way – emergency measures if you like, by the central bank – to pump liquidity into the banks in order to build up the balance sheets of those banks, enable them to access capital markets themselves, and push up asset prices so that the assets on their books improved.

A lot of that money went straight around in a circle, and was deposited right back at the central bank in the form of excess reserves. So the economy was never stimulated by quantitative easing! So that’s the first point. If you then reverse that through tapering, arguably it doesn’t make any impact either.

World Finance: And in reality, how exposed are emerging markets to US rate rises?

Jerome Booth: Very little. And you have to remember that emerging markets are the bulk of savers now. They are the next savers in the world. Their central banks own 80 percent of international central bank reserves.

What I call ‘core-periphery disease’ is this idea that the core affects the periphery, but we can ignore the effect of the periphery on the core. So one of the aspects of that is when people constantly ask the question, ‘How much money might leave emerging markets IF something happens in the US?’ And not asking the question the reverse way around. In other words, ‘How much money which is in the developed world, which is owned by emerging markets, might leave the developed world?’

So: maybe $15bn – that was one estimate a few years back, by the IMF – might leave the emerging markets if there was another, you know, big problem in Europe or the US. But the central banks and sovereign wealth funds in emerging markets own about $11trn – that’s nearly two orders of magnitude more – in just the sovereign, so-called liquid bonds, of Europe and the US.

So it gives you a much better picture of where the real bargaining power is.

If there’s another problem in the US – if there’s a bond crash, as is quite likely in a couple of years time – then you may well see a huge rush of savings out of the developed world, back into emerging markets, and those currencies appreciate.

[T]he economy was never stimulated by quantitative easing!

And the precedent for this is not something recent; it’s the last time we had huge great global imbalances, which was in 1971.

World Finance: Well a couple of weeks ago when the US announced their unemployment figures, the Indian currency for example dropped quite considerably. So what is the effect on emerging markets when rates rise?

Jerome Booth: If you have Indian central bankers, and Brazilian central bankers doing nothing when there’s weakness in their currency – because it’s actually convenient and it can help them export more – that doesn’t give you a good clue as to what might happen, and the overall trend of what will happen, given the state of global imbalances.

We have seen weakness, and it’s very easy and common for people to then extrapolate from that. And then say, ‘Oh well that’s the trend, and therefore that’s going to continue.’ And that would be a large error. Because what we’re talking about here is big structural shifts.

World Finance: Well the FT reported that analysts at Morgan Stanley pointed out that the central banks in developing countries have been struggling to accumulate foreign currency reserves for the best part of two years. But some countries and emerging markets such as China, for example, have huge forex reserves. So who will be the winners and the losers if rates rise?

Jerome Booth: I would actually argue against the comment that you quoted there! In many cases emerging markets have too many reserves.

One of the indications of this is they are often still fixated about current account surpluses. They shouldn’t be. When you’ve got big reserves it means you should have the confidence to be able to import capital, and manage the fluctuation in your currencies through active intervention.

What’s yet to happen is for them to be more active in their use of reserves, to reduce short-term fluctuations, and more confident that this gives them if you like, the self-assurance to be able to import capital. Which they should be doing! These are capital-scarce countries.

Now, they’re generating their own savings so the real issue is not that they should import more, but that they should stop exporting so much. But importing capital is also important at the margin, because foreign capital can help with transparency and governance and gives competition of ideas. So it should be welcome, and it still is.

That was always a problem back in the 90s, because things overshot. Now that you’ve got these big reserves, they need to change their policy stance and stop fixating all the time about ‘have we got enough reserves?’

What I call ‘core-periphery disease’ is this idea that the core affects the periphery, but we can ignore the effect of the periphery on the core

That doesn’t change your other point, which is that there are still some countries which don’t have enough reserves. But to be honest, all the major emerging markets have huge reserves.

World Finance: Unemployment figures have been largely disregarded as a tool for measuring economies, but the US is doing exactly that. So what would you say are the far-reaching effects, and what would be a better tool to do this?

Jerome Booth: I’m not saying that unemployment is not a useful statistic. I’m saying that unemployment typically has an impact at the margin on inflation. We have the NAIRU, we have the Phillips Curve, there’s a huge great history about this.

That doesn’t really work when you’ve got people who are simply not in the numbers, but are unemployed. That’s what I’m saying. And you know, that’s the reality in the US.

World Finance: Jerome, thank you.

Jerome Booth: My pleasure.