The exit from quantitative easing will be gentle, the United States Federal Reserve keeps saying.
The pace of reduction in asset purchases from the current rate of $85-billion a month will be gradual. It will depend on economic conditions. Nothing is predetermined.
Yet the yield on 10-year treasuries has surged from 1.7% at the start of May to 2.8%, helping to stoke a storm in developing economies that is starting to look very dangerous.
Hot money is flowing out of Asia and Latin America, pushing up effective interest rates in economies where rates of growth had started to slow anyway.
The Indonesian rupiah has fallen 11% against the US dollar in the past three months. The Indian rupee is off 13% in the same period.
Brazil, which two years ago was grumbling about global “currency wars" and the difficulties presented by an appreciating real, is now confronting the opposite problem: the real has fallen 16% against the dollar in three months. Much more of this, and we're looking at a proper crisis.
There are two main ways the tale could develop from here. A cheery plot line would see some of the currency interventions, such as Brazil's, succeed in providing a brake.
Investors might reflect that a gentle adjustment would deliver some long-term global benefits.
As Singapore's finance minister argued, it's in nobody's interests that ultra-low interest rates continue indefinitely if they just reinforce financial imbalances.
It's the rate of adjustment that matters and — in theory at least — most Asian countries are better equipped than in 1997 and 1998 to fight back. Back then, their foreign reserves were tiny. By and large, the reverse is true this time.
The Fed could also lend a hand by emphasising — again — its flexibility. As Nick Parsons, strategist at National Australia Bank, puts it, the Fed may be withdrawing the punch bowl but it will be serving mojitos: it is conceivable that US interest rates will stay at 0.25% for several years.
The alternative — and gloomy — script would involve the crisis starting to feed on itself.
A pile of foreign reserves is a handy weapon in a currency crisis but it's a weapon that, once deployed, has to be seen to work. India is top of the worry list.
Not much effect
Capital controls and market interventions have had little effect so far. They have merely encouraged alarm among foreign investors who are required to fund the yawning budget deficit.
Meanwhile the worry — not just in India — is that big companies have borrowed too heavily in dollars, a recipe for pain.
And what would follow a serious crisis in India, such as a call for assistance from the International Monetary Fund?
In the 1997-1998 crisis there was a domino effect as Thailand, Malaysia, South Korea and Indonesia were sucked in.
What we know about today's global economy is that it's even more interconnected. Which way will the tale go?
A muddling through is probably still the safer bet on the grounds that the economies of the US and parts of Europe appear to be recovering.
But a confident forecast? No. Quantitative easing was a grand monetary experiment. We just don't know how withdrawal will play out. — © Guardian News & Media 2013