Foreign Affairs Focus: Benn Steil on Fed Policy

Did U.S. Federal Reserve Chair Ben Bernanke cause the Ukraine crisis? "You can certainly say that Bernanke was at least the butterfly wings that precipitated the crisis," argues Benn Steil, senior fellow at the Council on Foreign Relations and the author of "Taper Trouble" in the July/August 2014 edition of Foreign Affairs. "I would argue that if the Fed had remained dovish, say for another six months or so, it is possible that Ukraine could have gotten over this hump and Yanukovych would still be in power today."

Steil recently sat down with Foreign Affairs Editor Gideon Rose for a wide-ranging conversation on the international consequences of Fed policy. A full transcript is available below:

ROSE: Hi there. I'm Gideon Rose, editor of Foreign Affairs. Welcome to another edition of Foreign Affairs Focus. Today, we have the distinct honor and privilege of having Benn Steil of the Council on Foreign Relations with us, who's going to talk about his article, "Taper Trouble."

Ben, most people think of the U.S. Federal Reserve as a domestic American institution responsible for setting monetary policy, obviously involved in the economics of the United States. Your article argues that its actions have dramatic and significant international consequences. What do you mean by that?

STEIL: Very significant; in fact, I also argue that these are ultimately going to feed back over here and create even greater tensions in the global trading system. But go back to what I think was really the -- the seminal event, driving this message home may have last year when Ben Bernanke made his first famous taper comments.

This was an exquisitely hedged statement indicating that the Fed might, at some point in the coming months if economic circumstances are warranted, begin paring back or tapering its monthly purchases of U.S. Treasury securities and mortgage-backed securities.

The reaction in emerging market, currency and bond markets was immediate and savage. Emerging markets with a specific set of characteristics, in particular, countries running large current account deficits -- these are countries that were very dependent on the short-term capital inflows that were being facilitated by the Feds, kiwi, their monthly asset purchases, were hit very hard.

And in fact, the country that was hit most hard, was Ukraine, which was supporting an 8 percent current account deficit. At the time you saw yields on Ukrainian 10-year bonds soaring from under 7 percent up to near 11 percent, a level at which it stayed for most of the rest of the year.

ROSE: So Ben Bernanke caused the Ukraine crisis?

STEIL: You can certainly say that Bernanke was at least the butterfly wings that precipitated the crisis. I would argue that if the Fed had remained dovish, say for another six months or so, it is possible that Ukraine could have gotten over this hump and Yanukovych would still be in power today.

The reason I say this is that at 11 percent yield on 10-year Ukrainian sovereign bonds, Yanukovych was unable to keep rolling over his short-term debt. And as we know, he was ultimately forced into turning to Moscow for -- for a bail-out, and the rest is history.

ROSE: The Fed has enough troubles dealing with its existing two mandates for price stability and employment. Are you suggesting they're going to add a third mandate of taking care of the rest of the world's political and economic problems as well?

STEIL: No, I'm certainly not. The Fed does take an internationalist outlook, but from the perspective of making sure that problems overseas don't blow back in the United States. The example I gave in my article was in October of 2008, the Federal Open Market Committee meets to decide which emerging markets would be the beneficiaries of swap lines from ...

ROSE: So it already does make some decisions about international consequences, but it views those through a U.S. lens.

STEIL: Precisely. It determined that only four emerging market countries would be the beneficiary of such swap lines: Brazil, Mexico, Singapore, and South Korea. And how did they choose these countries? They decided that these countries were systemically important to the United States and that if the United States did not provide them with swap lines, an easy way to get access to U.S. dollars in a crisis, they might resort to other methods that would be harmful to us, for example, selling Fannie Mae and Freddie Mac's securities and pushing up mortgage prices in the United States.

ROSE: So you're a country that is gonna be effected by the U.S. Fed's actions, but for whatever reason, your interests aren't going to be taken into account by the Fed ...

STEIL: That's right.

ROSE: ...in the decision making. What do you do in that scenario?

STEIL: Well, in fact, the IMF did a really interesting study on this last year. They looked at the impact of so-called unconventional monetary policy in the United States in 2010 in emerging markets. And they identified three key characteristics that countries had, which weathered the turmoil well.

They had a low ratio of foreign ownership, but domestic assets. They were running current account surpluses. And they had large foreign exchange reserves. This translates directly into a policy agenda. Basically in good times, emerging market governments should apply a firm hand to keep their currency and imports down and their exports and foreign exchange reserves up.

Unfortunately, this is precisely the U.S. Congress's definition of currency manipulation. And therein lie the seeds of future trade conflict, as far as I'm concerned.

ROSE: So would you say -- is it fair to say that if the Fed isn't going to take others' interest into account, at least it should allow them to do the things that they need to protect themselves?

STEIL: Well, yes. I mean, it's impossible to argue, for example, that South Korea has not been an enormous economic success over the past 15 years since the Asia crisis. And one of the key factors in its success is that it's made itself a lot less vulnerable to financial crises. How has it done that? Partly by building up large U.S. dollar foreign exchange reserves, partly by running current account surpluses, partly by keeping their debt low.

Other countries, such as Chile in the 1990s, used very moderate considered restrictions on short-term capital flows in order to ensure that the economy wouldn't be buffeted by massive and rapid changes in foreign investor sentiment.

These are the sorts of things I think the United States in its own interest needs to allow in order to prevent crises like we're seeing right now in Ukraine from emerging and having very detrimental impacts back on the United States.

But in fact, we're moving in the other direction. You see enormous pressure on Congress coming from large U.S. export interests to impose anti-currency manipulation provisions into all future U.S. trade agreements. I think this is building up more political and trade conflicts for the future.

ROSE: Benn Steil, thank you very much.

STEIL: Thanks for having me.

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