Column : Beggar thy currency or thy self?

In practice, the strategy has proved not to be so straightforward. Moreover, part of the liquidity that the Fed injects finds its way into other countries' financial markets. Witness the surge in capital flows to emerging markets as investors chase higher financial returns. Complicating matters even more, these inflows have become less and less connected to the recipient countries' economic and financial fundamentals.

Many investors also feel the need to balance increasingly speculative investments ("satellite positioning") with much safer investments ("core positioning"). To meet the latter objective, they turn to prudently managed countries, placing upward pressure on their currencies, too—and, again, beyond what would be warranted by domestic fundamentals.

It is no wonder that more and more governments are worried about exchange-rate appreciation. In addition to short-term policy headaches, stronger currencies carry potentially significant costs in terms of hollowing out industrial and service sectors. So, after a varying mix of tolerance and "heterodox" responses, officials are pulled into loosening their own monetary policy in order to weaken their countries' currencies or, at a minimum, limit the pace of appreciation.

This period of expanding policy inconsistencies could prove to be temporary and reversible if central banks succeed in jolting economies out of their malaise, and if countries come to recognise that greater cross-border policy coordination is urgently needed.

The risk is that the phenomenon leads to widespread disruptions, as increasingly difficult national policy challenges stoke regional tensions and the multilateral system proves unable to reconcile imbalances safely. If policymakers are not careful—and lucky—the magnitude of this risk will increase significantly in the years ahead.

Mohamed A El-Erian is CEO and co-CIO of PIMCO, and the author of 'When Markets Collide'

Copyright: Project Syndicate, 2013

www.project-syndicate.org

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