Easy Money, Emerging Market Miracles and the Revival of Industrial Policies

March 9, 2011

by Andreas Hoffmann and Gunther Schnabl

While most advanced economies continue to suffer from high unemployment and record debt levels, monetary expansions in the advanced economies feed a tsunami of carry trades, hiking asset and raw material prices and accelerating growth rates in emerging markets from Brazil over the Middle East to China. While capital inflows drive miraculous catch-ups in many corners of the world – having learnt the lesson for the recent mega-crisis – the monetary authorities in the emerging markets are aware of the risk of financial market exuberance. They aim to prevent inflation and bubbles by absorbing surplus liquidity and tightening credit growth.

Yet by doing so, they cause distortions in the real sectors of their economies, which are not on the radar screen of the now ballooning financial supervision bodies.In line with Mises’ oil stain theory monetary policy intervention to bail out financial sectors in the advanced economies is followed by the revival of government intervention and industrial policy in the emerging markets.

How does it work? Speculative capital inflows and accelerating reserve accumulation in emerging markets are counteracted with sterilization measures and capital controls. In Brazil capital controls prevent a free allocation of capital to the best uses. In China non-market based sterilization and credit rationing is used to further stimulate the already overinvested export sector. While sterilization keeps credit generally tight (for instance for consumers), the export industries and state owned enterprises enjoy low-cost credit to keep the capital stock growing. As sterilization operations also hold inflation low, the real exchange is kept undervalued what helps to clear the overproduction on international markets.

Even worse: In countries with large raw material sectors, the global liquidity driven raw material price inflation causes huge public surpluses, which are distributed by mostly autocratic governments ad libitum. Rising public expenditure and/or thriving stabilization funds replace “competition as a discovery procedure” by guided structural change and state funded economic development. Dubai loves to invest in a palm shape island and Babylon towers. Russian bureaucrats see potential in pharmaceutical and military industries. Venezuela and Algeria pump money into social security systems to create political stability. The Saudi Arabian General Investment Authority sets up glamorous new cities that shall create more jobs in the name of the King.

While all these policies may be well intended, they distort markets, as public investment in subsidized industries misguides private investment decisions. Investment in industries, which are picked by the government, is risky. Once the golden rain stops, the readjustment will set in. This may happen, once the advanced economies exit from easy money policies as growth prospects lighten up or inflation accelerates. Only then, it will be obvious which of the many economic miracles which we currently observe is real and which is an illusion.

13 Responses to “Easy Money, Emerging Market Miracles and the Revival of Industrial Policies”


  1. This post is packed with keen insights and good analysis. It is a timely piece of monetary dynamics.

  2. Roger McKinney Says:

    Could someone discuss rising prices in China? There seems to be a limit to the state’s ability to sterilize.

  3. chidemkurdas Says:

    The central argument in this post — “In line with Mises’ oil stain theory, monetary policy intervention to bail out financial sectors in the advanced economies is followed by the revival of government intervention and industrial policy in the emerging markets.” — may be the most important policy lesson of the past year. People should pay more attention to what this means for countries like Brazil, a current favorite among big investors.

  4. Mario Rizzo Says:

    This analysis is quite revealing and unfortunately alarming. The economic journalist Henry Hazlitt once asked the question in the post-World War II world: “Will dollars save the world?” Might we not ask the question: “Will dollars destroy the world?”


  5. Shortly after becoming Treasury Secretary under President Nixon, John Connelly met a delegation of Europeans complaining about the dollar. Connelley told them: “It’s our currency, but your problem.” What Bernanke is saying to central banks in emerging markets is not all that different.

  6. chidemkurdas Says:

    Interesting anecdote, Jerry. There is one big difference between then and now. Then, the US was the creditor country and those complaining were debtors. Now, the US is the debtor. One wonders what effect this role reversal will have.


  7. @ all

    We thank you for the comments.

    @Roger

    Indeed. China faces a dilemma. It wants to keep up production but has to lower overall inflation. This is not an easy task. It can only work via more distortions.


  8. Besides, it seems that turbulence is on its way.

    Today the Total Return Investment fund of Pimco has announced to not hold any US Treasuries anymore. This is the world’s largest fund for investment in treasuries. Also, Spain was downgraded by Moodys.


  9. In Asia, inflation is high and rising. Now core inflation is also rising there. Will the Fed’s exportation of inflation end in its reimportation?

  10. chidemkurdas Says:

    As best I can understand, the Fed is betting that commodity price increases will not affect core inflation in the US. What’s happening in China, a major US trading partner, weakens the Fed’s argument but so far they don’t seem to think it matters enough.


  11. Chidem,

    There is a view that putting pressure on China is a reason, if not the main reason, for QE2.

  12. Andreas Hoffmann Says:

    Jerry and Chidem,

    I believe that Chinese inflation will have effects on the US either via the goods market channel or repercussions from a crisis in China. First, rising consumer prices are imported. Second, when the Chinese export sector goes bust, prices should hike around the world.

    Alternatively, if China is successful in fighting inflation and continues to buy US bonds, inflation in the US will hike as -again- US long-term interest rates are held low. And they are already at 3 percent.


  13. [...] Easy Money, Emerging Market Miracles and the Revival of Industrial .Mar 9, 2011 by Andreas Hoffmann and Gunther Schnabl. While most advanced economies continue to suffer from [...]


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