Geo-Graphics

“In considering whether a recalibration of the pace of its asset purchases is warranted,” Fed Chairman Ben Bernanke offered back on May 22, the Fed “will continue to assess the degree of progress made toward its objectives in light of incoming information.” The reaction to this modest and heavily hedged statement in emerging-market currency and bond markets was swift and brutal. But the pain was not shared equally. As the top figure in today’s Geo-Graphic shows, those countries whacked hardest by taper-talk were those with large current-account deficits—Turkey, India, Indonesia, and Brazil. These nations had been cruising on the QE3, comfortably financing excesses of consumption over production with dollars desperately scouring the globe for return. But the mere hint of a QE3 docking was enough to send foreign investors into paroxysms of fear over depreciation and default risk. Not surprisingly, as the bottom figure shows, their currencies were also the biggest beneficiaries of last month’s taper-interruptus—the Fed’s decision to back away from a strongly hinted-at September pullback in asset buying. The message received in emerging markets was clearly not one the U.S. Treasury had wished to send—in good times, apply a firm hand to keep your imports and currency down, and exports and reserves up. The U.S. Congress may cry “manipulation!”, but history shows that this is a small price to pay for taperitis protection. Note: No data on Brazilian 10-year government bond prices are available from Bloomberg after July 2, 2013. Financial Times: Turkey Relieved at Fed Decision to Postpone Taper Beyondbrics: Ben Bernanke and Responsible Parenting Real Time Economics: Learning to Love the Fed Taper IMF: Global Impact and Challenges of Unconventional Monetary Policies   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

Geo-Graphics posts in July 2010 and 2012 showed that Paul Krugman’s devaluation-driven “Icelandic Miracle” was nothing of the sort – a figment of his having chosen the most favorable possible starting date (Q4 2007) for his Baltic (and Irish) economic-performance comparisons.  Move it forward or back, and Krugman’s story collapses like a warming arctic ice shelf. Our 2012 post particularly upset him - the poor thing being so weary of having to deal with benighted economic illiterates.  In suggesting that Krugman look not just at how his four chosen countries had performed relative to their pre-crisis peaks, but how they had performed since they hit bottom, we were apparently guilty of knowing nothing about business cycles – which to Krugman’s mind means believing that positive output gaps can actually exist. Now that the IMF’s Olivier Blanchard, Mark Griffiths, and Bertrand Gruss have explained to him in a 39-page Brookings paper what we failed to get through to him in a simple sentence last year – that Latvia, whose inflation rate topped 15% in 2008, was producing well over its potential output at its pre-crisis GDP peak (undermining Krugman’s post-peak analysis) – Krugman has changed his tone on the Baltics abruptly. (One can’t credibly call Olivier Blanchard an idiot, now, can one?) Last year Krugman was peeved at having to defend his “Icelandic Miracle” claim against evidence that the competition had actually done as well or better, without devaluation; now, however, faced with more of the same evidence from a different source, he’s content just to quarantine Latvia as “a more or less unique case.” But let’s not quibble about esoterica like output gaps.  Let’s address Krugman’s “Icelandic Miracle” claim on his own terms – that is, let’s just update his very own post-peak “Icelandic Miracle” figure. Here it is, folks: Iceland, whose currency lost half its value against the euro in 2008, vs. Estonia, Latvia, and Ireland, all of which were euroized or pegged to the euro over the entire period . . . In the updated figure, Estonia comes out on top, by a lot – well above Iceland, which performed no better than Latvia or Ireland, even using a starting date chosen by Krugman to make Iceland look as good as possible. In short, Krugman credited Iceland’s post-crisis devaluation for an economic “miracle” that clearly never was. In fact, Iceland is now facing a new foreign-debt repayment crisis brought on by the capital controls Krugman extolled. Hark, O ye Greeks: Beware pundits touting miracles.  The floating krona didn’t bring one to Iceland, and the drachma won’t bring you one either.   Financial Times: Dissatisfied Icelanders Question Myth of Post-Crash Success VoxEU: The Collapse of Iceland's Banks Wall Street Journal: IMF Warns on Icelandic Economy   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”