A strengthening U.S. market may not be the best medicine for an ailing world economy.
Despite a poor showing by the U.S. dollar against other major currencies this past Monday, the Federal Reserve's decision to taper U.S. quantitative easing (QE) programs may not have been the best solution to the problem. This policy decision, championed by departing chairman Ben Bernanke, begins a $10 billion reduction in the nation's QE program with more reductions expected later this year.
The international community is mixed in their reactions. With $10 billion representing the monthly QE investments by Turkey, Chile, Ukraine, India, Indonesia, Thailand, and Brazil combined, these investments were a key function of the U.S. effort to buoy the global market. The lack of these (and similar) investments may cause a systemic fleeing of capital from statistically less safe foreign markets to a moderately secure American market.
Tapering and why it matters
Bernanke brought the term "tapering" to the public in May of this past year, using it to describe a gradual scaling back of U.S. quantitative easing. Considering that QE is a tool to support under-performing economies, this has led established economies such as the U.S. to invest a significant amount of funding to stimulate growth in less productive states. In the case of the U.S., this bond-based investment reached its highest levels last year at a rate of $85 million a month.
For countries in the midst of market instability, this reduction in investment could be a deathblow to any attempt to revive markets after the 2008 market slump. India, for example, has recently been enacting a set of reforms that have managed to halt the recent slide of the rupee. The sharp reduction of U.S. funds in the world market has caused RBI head Raghuram Rajan to comment that "international monetary cooperation has broken down." He remarked further that the developed world has a responsibility to continue to work with struggling markets and that unilateral decisions cannot be made without further considering the effect on the international community.
India represents the best position of those affected by this taper. There are other states in a similar situation, all of which lie in markets with extremely fragile manufacturing capabilities. Considering the addition of Thailand and Brazil to the list of those affected, this distinction is distressing due to the market share controlled. While such a reduction of market activity allows for other players to interact with the market slack gained, reduced activity in regional players (such as Brazil and India) means increased market instability and possibly volatile prices.
It could be worse
Not all markets affected by this reduction are doomed. China, despite its slowdown in domestic market activity, will not be as greatly affected. Neither will Mexico. Neither will any market that has not invested funds gained from U.S. quantitative easing to prop up industry. Emerging markets large and liquid enough to make even limited investments are now being given the opportunity to increase market share at the expense of previous warhorse economies.
Unfortunately, even these markets may wither in the long term if the U.S. economy continues to strengthen, though that is far from certain. Recent job reports see a slight slowdown, but Bernanke's successor Janet Yellen is committed to advancing this cause further if positive growth is maintained.
To be perfectly frank, the world community may be reacting prematurely. Despite the recovery of the U.S. economy and the aforementioned commitment made by Yellen, the recent U.S. jobs report indicates slower growth than previously thought. If tapering continues to result in further reductions of U.S. investment, then economies based on tenuous manufacturing capabilities will likely regress further. Interestingly, while many officials of affected countries publicly condemn the U.S. action, private remarks indicate little ill will in the long term.
Whatever the result in the world, this could mean a prime banking environment for domestic U.S. firms. Low government investment in buoying the U.S. economy means more trust, increased domestic money supply, and potential revenue growth.