Fed Up

What do Ron Paul and the President of Ghana have in common? One is a former libertarian congressional representative from Texas and perpetual presidential candidate; the other is the reformist leader of a sub-Saharan African nation with a GDP per capita nearly one-twelfth that of Texas. Yet both, separated by an ocean of differences, could find common ground over one issue: dislike of the United States Federal Reserve.
In 2011, Congressman Paul alleged that the Federal Reserve “will eventually destroy our currency” through overprinting and inflation. African leaders might well be muttering the same thing. Yet unlike Paul, they have not been derided and written off by mainstream economists. Instead, this logic has become so engrained in economists’ minds that it has become the 21st century version of the time-tested excuse of “foreign meddling” straight out of many leaders’ playbooks. This is not just an African story: from India to China to Brazil to South Korea, economic policymakers have taken to pointing fingers at Washington. Ghana’s example is particularly ripe, however; upon the receipt of poor economic news, President John Dramani Mahama simply blamed the Federal Reserve for his country’s economic woes. The real explanation, however, may not be so simple.
In 2008, the U.S. Federal Reserve started to purchase tens of billions of dollars of debt each month in a bid to stimulate the economy. Two years later, the bank upped monthly purchases, and they were increased yet again in 2012. By that time, the Fed was purchasing $85 billion of U.S. government debt and “mortgage backed securities” per month. It was an effort at monetary stimulus unprecedented in modern economic history.
As America’s economic policymakers pumped money into the economy, some of this cash began to reach emerging markets. From India to Argentina to Russia, cheap money propelled huge growth. Credit was inexpensive and interest rates were low, so money flowed from the developed world into more risky investments in the developing world. The logic was simple: investors were more willing to take the risks inherent in emerging markets because interest rates had been driven so low in the West.
Fast forward three years, and now the Fed is attempting to unwind its massive purchases. Then-Chairman Ben Bernanke and Vice Chair Janet Yellen spent much of late 2012 and early 2013 equivocating on how and when they might go about ending their massive doses of economic steroids. In May of last year, the Fed announced it would finally start tapering its purchases. The reaction was quick and severe. Developed markets plunged; developing markets plunged even more.
The reaction was branded the “taper tantrum,” as stock indices in Turkey, Indonesia, Poland, Brazil, Hungary, South Africa, Nigeria, and more took a nose-dive. What went wrong?
As the Federal Reserve began to pair back the life support it had been providing to the American recovery, investors panicked, sensing an end to near-zero interest rates in the West. The result was a dramatic outflow of capital from the emerging markets back to the developed world. Growth in these peripheral countries, powered for the past several years by cheap credit provided indirectly by the U.S. government, began to stall. Now, as the Federal Reserve has cut off bond buying entirely, emerging markets fear that their prospects of growth will suffer even more. Or so the story goes.
Africa presents a broad spectrum of economies to evaluate the effects of Federal Reserve policy, with impoverished states, middle-income nations, emerging markets, and commodity exporters. This brings us to the case of Ghana, where President Mahama has been blaming the Fed for the country’s plummeting growth, charging that its policies have skewed the Ghanaian economy by devaluing its currency and making it harder to refinance its debt. In reality, American monetary policy is far from the cause of its woes.
In some sense, Ghana is a canary-in-the-coal-mine case for weaker African economies. Amadou Sy, a senior fellow in the Africa Growth Initiative at the Brookings Institution and former senior official in the IMF’s Monetary and Capital Markets Department, stated in a conversation with the HPR that Ghana is “the key country to look at” in Africa, as it illustrates how fundamentals can affect sensitivity to Federal Reserve policy. Basic economic conditions in Ghana have deteriorated in the past several years, and Sy argued, “Ghana was very fragile because Ghana has a twin deficit … a current accounts deficit and a fiscal deficit.” The fiscal deficit, or budget deficit, has doubled over the past three years. The current accounts deficit—a lower-is-better measure of the stability of the country’s trade with the world—has also ballooned. Meanwhile, the African Development Bank has reported the existence of severe infrastructure problems, the already-double-digit inflation rate hit a four-year high in August, and the prices of major export commodities have fallen nearly 40 percent since 2011.

Robert Bates, Professor of Government and African-American Studies at Harvard University, added in an interview that Ghana is “wounded, and these wounds are all political.” The current government, he noted, had borrowed more than all the previous governments combined. The result has been a fall in growth rates from 7.1 percent last year to a projected 4.5 percent this year along with a 40 percent devaluation in the Ghanaian cedi. Federal Reserve policy undoubtedly played a role in the current economic problems, but it was Ghanian policymakers themselves that fueled this vulnerability. “It depends on how these countries have relied a lot on foreign money,” Sy stated. “Take the local bond market in Ghana: more than one investor out of five in the local bond market is a foreigner, so you are going to be more vulnerable to changes in sentiment.”
An even more extreme case is South Africa, a country more deeply enmeshed in global financial markets. The argument for Fed-blaming is admittedly much stronger there. The South African rand is one the world’s most liquid currencies; it is incredibly easy to move money in and out of South African-denominated investments. As a result, the country is extraordinarily vulnerable to any shifts in global capital and investment flows. Indeed, the rand has fallen nearly 20 percent against the dollar since the Fed announced the details of its taper. Yet even South Africa is not a model country dastardly sabotaged by a foreign central bank. Its current accounts deficit has grown substantially, which caused credit agency Moody’s to downgrade South Africa’s debt. Systemic problems with infrastructure, education, and political infighting have dogged the country for years. Indeed, Morgan Stanley branded South Africa one of the “Fragile Five” countries that are over reliant on foreign investment, a systemic problem that the Federal Reserve did not create.
Nigeria provides an even starker example of the relative unimportance of Federal Reserve policy on African nations. While some effects of the Fed’s taper are being felt, Sy explained that Nigeria’s oil has helped buffer the changes in the global economic winds. This year, Nigeria’s economic fluctuations have been correlated not with Federal Reserve decisions but rather falling oil prices. Indeed, Bates remarked that in times of high oil prices, the Nigerian economy experiences a “vitality that eludes the current government’s [mismanagement].” This does not demonstrate the unimportance of good governance but rather the importance of the country’s domestic economic and political conditions.
What about more stable countries? Kenya, for example, has maintained steady growth over the past year. Sy noted that Kenya serves as a stark contrast to Ghana in how to manage capital flows properly. While some sectors of the economy are exposed to the volatility of global capital flows, it is in “the bond market where they’ve been very careful in the government itself and its regulation.” In fact, the IMF recently lauded Kenya for governmental and financial sector reforms that, especially when combined with investments in key sectors like infrastructure and communications, seem poised to accelerate growth.
These sort of policies can radically change the impact of capital flows. In São Tomé and Príncipe, Bates lauded politicians for having “gotten their act together to manage their economy in a way that sterilizes the impact of the inflow of foreign dollars.” Widespread citizen education campaigns created what Bates described as “a very great deal of citizen awareness and organization” that helped ensure that trade revenues and investment wouldn’t be squandered. Though this situation is slightly different from that of other countries—São Tomé had oil money while South Africa and Ghana had foreign investment—the message is that policy decisions matter a lot more than the actual capital flows themselves.
This is not to say that Federal Reserve policy, or global macroeconomic conditions writ large, is irrelevant. It is important, but mostly at the margins. The effects that do exist are, to a large degree, the result of domestic decisions. “Investors are discriminating more in looking at countries’ fundamentals,” Sy stated, so ultimately, taper or no taper, “if your country is growing well, [if] it has healthy growth with good fundamentals, you are going to attract foreign investment.”
The marginal effects of Federal Reserve policy are rarely strong enough to upset an otherwise healthy economy. Without a doubt, the massive and unprecedented monetary policies adopted by American, and to a lesser extent, European policymakers in response to the 2008 financial crisis have had and continue to have serious implications for emerging markets, particularly smaller ones. But while these policies can rock the boat, it is unlikely that they alone could capsize whole nations. Those with strong structural foundations will weather the taper and continue to attract foreign investment. It is a tempting story to see these developing economies solely as victims of self-interested American decisions, but that picture is far too simple. As Sy put it, “the U.S. Fed is one factor—an important factor—but it is only one factor.” In reality, Ghana, South Africa, and other similar countries must look inwards before they can look outwards.