The Bernanke Tide What the Fed gives to emerging markets it also takes away

The Bernanke Tide

What the Fed gives to emerging markets it also takes away.

Jan. 24, 2014 6:41 p.m. ET

In Warren Buffett‘s famous formulation, only when the tide rolls out do you see who’s been swimming naked. So it goes in emerging markets with the skinny dippers being exposed as the Federal Reserve tapers its unprecedented bond-buying.

That’s the story of the week in global financial markets, as it becomes clear that some of the swimmers need a better workout regimen. The last few years have been good for countries such as Brazil, Turkey and Indonesia as the Fed’s low-interest-rate policies have had investors hunting for yield around the world. Any semi-respectable country without Hugo Chávez or Ayatollah Khamenei in charge could attract foreign capital. Not all of that money went to productive use. And now that the Fed seems set on drawing down the QE era, investors are hedging their bets and returning to dollar and euro assets.

The hardest hit are the countries with policies least able to stand without the Fed prop. That includes Argentina, which the Kirchner clique has run like Venezuela without the populist charm. Turkey’s lira has taken a bath amid the political showdown over corruption, a large current-account deficit, and monetary policy that has been too easy for too long. Russia’s ruble is also hitting new lows against the euro, as its economy increasingly looks like a one-act play (oil).

China is a special case because its growth jitters have more to do with the withdrawal of its own domestic financial stimulus. But China’s hints of slowdown, and the probability of a big bill for cleaning up bad debts, have spooked investors elsewhere worried that global growth may slow.

One lesson is that countries are going to have to improve their policies to attract capital. South Korea is in better shape than most in part because it has struck free-trade agreements that have made it more globally competitive. Mexico’s energy and other reforms have investors optimistic about its growth prospects and burgeoning middle class. The end of Ben Bernanke’s Fed tide will have its uses if it spurs the kind of tax, trade and investment reforms that have been put off in too many places.

The question is how much damage will be done as this global adjustment takes place. One of the conceits of the Bernanke era has been that U.S. monetary policy need only be concerned with America’s domestic economy. The rest of the world would take care of itself. This was always an illusion.

A country that runs the world’s reserve currency is also the world’s central banker, as the rude shifts in capital flows have shown. The last week’s exchange-rate gyrations are a repeat of what happened last summer when Mr. Bernanke made clear he wanted to begin tapering the Fed’s bond-buying. A few bad weeks in global markets at the time caused the Fed chief to blink in September and put off the start of tapering until December. Now the Fed is leaking that it will keep tapering at its meeting next week, probably by another $10 billion, and markets are moving again.

Will the Fed blink again? This will be Mr. Bernanke’s final meeting as chairman and it’s unlikely that the Open Market Committee will pull a surprise after the recent leaks. Mr. Bernanke will go out having set the Fed on a tapering course. But continued market ructions will put the pressure on new chairman Janet Yellen, especially if they spill into U.S. stocks and affect U.S. business and consumer confidence.

Yet sooner or later the world will have to adjust to a normal monetary policy. QE and near-zero interest rates can’t last forever without running risks of even more misallocated capital and market distortions. The end of the Bernanke tide was always going to leave somebody naked, and the sooner they get dressed the better.