Salient to Investors:

Alexander Friedman at UBS and Kiran Ganesh at UBS Wealth Mgmt write:

The dollar’s role as the de facto global currency for more than 6 decades has made Fed monetary policy one of the US’s greatest exports. Up to 60 percent of global transactions are conducted in US dollars, over 1/3 of world output is produced in dollar bloc economies.

Importing monetary policy can be dangerous, as seen in southern Europe recently and in Asia during the 1997 financial crisis. The lack of more trouble may be because, for most of the past 60 years, the US has been the world’s largest economy and its locomotive.

This is changing. Falling US contribution to global growth means that economic cycles around the world are becoming both less synchronized and more divergent, with Fed monetary-policy becoming incongruous with the economic environment of much of the rest of the world.

Jeffrey Frankel and others argue that countries that experience swings in exchange rates or capital flow as a result of Fed decisions should accept them as a normal part of a global re-balancing, whatever the cost, or benefit, to their international competitiveness. But this is not realistic, because sovereign nations will instinctively seek to protect their own national interests above the common good.

The IMF says countries that attempt to control exchange rates are more likely to experience credit booms – e.g. over 20 percent annual credit growth in Brazil, or the overstatement of Chinese export data.

Investors are convinced that the Fed is on a tightening path, so a withdrawal of capital from emerging markets threatens to expose these imbalances. In the near-term, it will mean higher non-performing loans, liquidity shortages and slower growth, and more frequent boom-and-bust credit cycles. The coming years will show that such interventions are neither in the common nor the national good.

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