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The International Consequences of Fed Policy
BENN STEIL is a Senior Fellow and Director of International Economics at the Council on Foreign Relations. He is the author, most recently, of The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order.See more by this author
In April 2013, Ukraine was sporting a massive current account deficit of eight percent, and it badly needed dollars to pay for vital imports. Yet on April 10, President Viktor Yanukovych’s government rejected terms set by the International Monetary Fund (IMF) for a $15 billion financial assistance package, choosing instead to continue financing the gap between its domestic production and its much higher consumption by borrowing dollars privately from abroad. So a week later, Kiev issued a ten-year, $1.25 billion eurobond, which cash-flush foreign investors gobbled up at a 7.5 percent yield.
Everything seemed to be going swimmingly, until May 22, when the U.S. Federal Reserve’s then chair, Ben Bernanke, suggested that the Fed might, if the U.S. economy continued improving, soon begin to pare back, or “taper,” its monthly purchases of U.S. Treasury and mortgage-backed securities. The Fed had begun the purchases the previous September in order to push down long-term interest rates and encourage private lending; their end would mean higher yields on longer-maturity U.S. bonds, making developing markets decidedly less attractive. Investors in Ukrainian bonds therefore reacted savagely to the taper talk, dumping them and sending their yields soaring to near 11 percent, a level at which they would remain for most of the rest of the year.
Ukraine’s financial problems had been mounting over many years, but it was the mere prospect of the Fed pumping fewer new dollars into the market each month that pushed the cost of rolling over its debt -- that is, paying off old obligations with new bonds -- beyond Kiev’s capacity to pay. Had the Fed stayed dovish, Ukraine could have at least delayed its financial crisis, and a crisis delayed can be a crisis averted. Yanukovych ultimately turned for help to Moscow, which successfully demanded that he abandon an association agreement with the European Union in return. Ukrainians took to the streets -- and the rest is history.
But that history has, until now, overlooked the role that the Fed’s taper talk played in the toppling of Yanukovych and the chaos that followed. And this insight becomes even more worrisome when you consider that Ukraine is but one of a great many fragile, dollar-dependent countries with markets that can be sent spinning wildly at the mere suggestion of a change in Fed policy.
DOLLAR FOR DOLLAR