When Federal Reserve Chairman Ben Bernanke talks, everyone around the world listens. That will be more true that usual on Wednesday when Bernanke announces whether the Fed will scale back, or “taper,” its unconventional economic stimulus program known as quantitative easing, or QE for short. The torrent of dollars that bond-buying scheme has pumped out have found their way into every nook and cranny of the planet, influencing currency values, stock markets, investment choices and overall growth from South Africa to Japan to Brazil. Whenever the Fed chooses to taper, the impact will ripple through the entire global economy.
The mere expectation of tapering has already roiled financial markets over the past three months. The dollar gravy-train had rolled into high growth, high potential emerging markets, but after the Fed signaled its intention to taper in May, those flows suddenly reversed. Anticipating higher interest rates and a stronger dollar, investors yanked billions out of emerging markets, causing their currencies to tumble in value.
Former darlings such as India and Indonesia were especially hard hit. Though markets have somewhat stabilized, the negative consequences of the turmoil could persist. Local companies, which gorged on dollar-denominated debt in recent years, now find the burden of those borrowings has become much heavier with a more expensive greenback, constraining their ability to spend, invest and hire. Central banks in India, Indonesia, Turkey and other emerging nations have also been forced to hike interest rates to defend their currencies, which will have a further dampening effect on growth. Conditions got so scary so quickly, some analysts worried that tapering would spark another emerging markets financial crisis (though those fears seem exaggerated, at least for now).
(PHOTOS: Ben Bernanke Was Time’s 2009 Person of the Year — See Photos by Dan Winters)
In fact, the entire global economy may be facing heftier borrowing costs thanks to the taper. The yield on U.S. Treasuries — something of a benchmark for interest rates globally — has already risen, and rates on other government bonds, from Germany and the U.K., for example, have inched up with them. Higher interest rates generally suppress consumer spending and investment, slowing economic activity and job creation. That could be especially painful for Europe, where the troubled eurozone has just crept out of the longest recession in its history. Elevated rates could also place further strain on Europe’s weakest economies, especially Italy and Spain, which are already suffering from hefty debt, biting austerity and joblessness. If matters get bad enough, the European Central Bank may be forced to step in with some stimulus of its own.
The Fed is unlikely to be thinking much about all this during its discussions this week. Bernanke will make his tapering decision based on his view on whether the U.S. economy and labor market are strong enough to withstand the winding down of QE. But the big question facing policymakers, bankers, corporate executives and investors around the world is: Can the global economy withstand it? That is far from clear. The recovery is still fragile, with the IMF forecasting global GDP to expand an uninspiring 3.1% this year. Even high-powered emerging economies like China and India are enduring slowdowns of a severity not witnessed in many years. Fed tapering may be inevitable, but the world may not be ready.