Interview with Dr. Mohamad Hamade, Professor of Economics at AUIB

Firas Abi Mosleh

Introduction

Amid rising inflation in the United States, the series of increases (or ‘hikes’) in the US Federal Reserve (‘the Fed’) Funds Rate, or the target interest rate set by the Fed, put an end to the latest weak dollar phase in the historical “dollar cycle”. This might at first seem disinteresting to those who are not directly involved in the affairs of money, finance, and economics; or it might seem of little significance to those outside the US. However, in the reality of today’s globalized financial and economic structures and relationships, “Fed rate hikes” have strong and far-reaching effects world-wide, as they directly affect a multitude of macroeconomic variables in the US and in countries all over the world, heavily influencing the overall performance of economies and the living conditions of people.

Foremost among the variables affected by Fed rate hikes are short-term and long-term interest rates, foreign exchange rates, or the values of world currencies vis-à-vis the US dollar, and consequently the Debt Burden of many countries, especially those of the “Global South”, as well as the quantities and cost of credit extended by financial institutions, and thus Investment and Employment rates, Output, or the quantity of goods and services produced in an economy, and general price levels. Significantly, Fed rate hikes have historically caused Capital Flight out of countries around the world towards US banks mostly, chasing higher interest rates and relatively secure investment; especially as these rate hikes have often coincided with major regional crises_ whether economic, political, military, or full-spectrum conflict_ as happened in the Latin American debt crisis of the 1980s, and then the East Asian economic crisis of the 1990s, as most prominent examples, and now in East Europe, exacerbating the phenomenon of capital flight, and thus forcing central banks around the world, especially those in unstable regions, to raise interest rates in an attempt to curb capital flight, thus slowing or inhibiting growth and development, or even instigating De-development, as productive enterprises go bankrupt and assets are sold to foreign capital at floor prices.

What preceded might strike many as exaggerated, yet it is the reality of the globalized economy where the US dollar had become the dominant currency, especially after its decoupling from gold in the year 1971, and securing its position as the currency in which are primarily priced the world’s foremost strategic goods, namely oil and gas… until recently, at least. Our focus here is on the feasible short-term and long-term policies that governments of countries of developing and emerging economies may adopt to mitigate the adverse effects of Fed rate hikes, especially in a context of crisis and volatility. Also in question here is the very structure of the global financial system, and emerging or possible alternatives. These questions are put forth and discussed in an interview with Dr. Mohamad Hamade, Professor of Economics at the American University of Iraq-Baghdad (AUIB).

 

The Ripple Effects of Fed Rate Hikes

“Demand for the dollar started to increase a few months ago, because people expected that the Federal Reserve will increase the interest rate” in response to high and rising inflation in the United States, as this is the policy of choice to slow the economy down, thus controlling inflation, says Dr. Hamade, reiterating that demand for the dollar increased even before the interest rate was increased, showcasing regular economic dynamics, where expectations directly affect prices, interest rates included (the latter may be regarded as the price put by credit institutions on borrowing funds). The Fed “has the luxury” to raise interest rates in order to curb inflation because “the US economy is growing at a very healthy high rate, almost 6% in 2021. So, when you have high economic growth, you can afford to slow the economy down by raising the interest rate,” explains Dr. Hamade.

“What happens to economies all over the world when the US raises its interest rate? The dollar gets stronger, meaning that other currencies get weaker,” explains Dr. Hamade, citing the depreciation of the Euro vis-à-vis the dollar after the first Fed hike in 2022 (one Euro was 1.09 of a dollar by the end of March). For net importer countries, a stronger dollar hurts, as it causes inflation, with imported products becoming more expensive, adds Dr. Hamade. Furthermore, as net importers are usually indebted, a stronger dollar also means increased Debt Burden, greatly weighing upon developing countries in particular. As for net exporting countries such as China, that “was historically accused by the US of intentionally lowering the value of its Yuan,” a stronger dollar is beneficial, though “within limits,” as its products become relatively cheaper and its imports more expensive, enhancing its Trade Balance, points out Dr. Hamade.

 

“Imported Recessions”

However, most countries around the world, whether net importers or exporters, are generally forced to follow suit when the Fed hikes its rate, in an effort to limit capital outflow, thus slowing down their economies, adds Dr. Hamade, explaining that where growth rates were already low, this would cause “Imported Recessions,” specially as “the US is expected to continue raising its interest rate” by a series of hikes, which “compounded would total a little more that 3%,” putting significant stagnation pressure on weaker economies.

 

 A Historical Perspective

The Iranian Revolution in 1979 created a “world-wide recession” by causing oil prices to rise significantly, as “the West got nervous about what was going to happen to oil… this created a recession all over the West, which they got over in 1981, but with very high prices,” recalls Dr. Hamade, pointing out the highly consequential Fed hikes of that year, when “Paul Volcker, then-Chairman of the Fed, created a recession, (or even) back to back recessions, as he had to increase the interest rates to curb inflation, slowing the economy down into yet another recession… So, many times we have to take some difficult, lesser of evils, decisions.”

However, the aforementioned crisis is closely intertwined with what is known as the Latin American Debt Crisis, which had its roots in the 1970s’ borrowing spree, fueled by a surge of “hot money,” or fast-moving capital that chases lucrative short-term interest rates in different financial markets. As to where that bonanza of credit money originated, Dr. Hamade elucidates:

 

Petrodollars and Speculative Capital

“It all started with the 1973 Arab-Israeli October War, when the price of oil rose significantly. Before that, water was more expensive than oil, and all of a sudden, the price of oil quadrupled,” giving Arabian Gulf countries in particular great windfall revenues and wealth which “they deposited in Western, or more specifically US banks,” Dr. Hamade says, explaining that those banks saw that “the easiest way” to deal with “these huge sums going their way” was to lend them (as what came to be known as “Petrodollars”) to “sovereign nations (that) don’t go bankrupt”, quoting the Chairman of Citibank then. Those were the countries of Latin America, where most of the borrowed money was consumed by rampant corruption, as in overinflated prices of public works, or was misinvested, as in put into unproductive projects (or into current spending), according to Dr. Hamade, who holds that these countries’ economic predicament was later only “complicated with the increase in interest rates,” instigated by the Fed rate hikes, and that the latter “were not the reason why they went bankrupt. Mexico, Argentina, Brazil, (and other Latin American countries) went bankrupt because they borrowed money that they did not invest in economy-stimulating activities, but rather went into corruption, and thus they ended up with only debt on their hands.”

Nevertheless, what was said about corruption being the main culprit behind Latin America’s ruin in the 1980s is certainly not true of “The Asian Tigers” (South Korea, Taiwan, Singapore and Hong Kong) and other East Asian countries like Malaysia, that had been developing at a very fast rate in the Fifties and the Sixties, even in the Seventies, and they were always commended for their vision, industriousness, diligence, and efficiency.

 

Asset Loss as “Part of the Game in a Capitalist Economy”

According to several highly regarded economists_ including Joseph Stiglitz, former chairman of the Council of Economic Advisers in the Clinton administration and former Chief Economist and Senior Vice-President of the World Bank_ capital flight induced by Fed rate hikes was the major force behind the East Asian economies’ crisis in the late 1990s, after their years of renowned rapid industrialization and development. When economic crisis struck in Latin America and East Asia, these countries’ asset prices hit rock bottom, only to be bought later at floor prices by the very financial institutions that had extended them credit during the “weak dollar” phase of the “dollar cycle”. In both regions’ cases, huge assets were lost to the same speculative capital that reversed direction time and again, chasing short-term profit.

“I think this is part of the game in a capitalist economy,” maintains Dr. Hamade, regarding speculative capital and asset loss within the globalized financial architecture and its workings, saying that the question that should be asked in this context is “what can you do on the short term and the long term,” particularly as developing and emerging economies, to guard against the volatility of speculative capital?

 

Short-Term and Long-Term Policies to Mitigate Risk

Interest Rates and Capital Controls

In the short term, Dr. Hamade holds that there is little policy choice other than “following the Fed’s rate, to limit a bit capital flight,” even though this “hurts the economy,” at least by decreasing investment and thus inhibiting growth, if not eliciting de-development. Dr. Hamade opposes introducing Capital Controls to prevent capital flight, as this would be “problematic,” demanding no less than a “drastic change of economic system,” impermissible, in Dr. Hamade’s view, outside the case of major crisis, “as with what happened in Greece, or recently in Lebanon… You cannot say that whenever the US raises its interest rate, I would implement capital controls, as the long-term effect of this is very negative,” namely driving investors away.

Yet, capital controls are a salient feature of China’s system, and still, Western financial institutions in particular invest heavily there, we ask. “Absolutely,” answers Dr. Hamade, explaining that consistency is of essence in this regard, as capital controls are known to be ‘part and parcel’ of China’s system, whereas “uncertainty hurts investment.” However, not all countries are in a position to implement China’s system of capital controls: Simply put, “China is a huge exporter, and thus always enjoys foreign exchange revenue, whereas a non-exporting country can’t impose capital controls, because no one then would invest in its economy,” affirms Dr. Hamade.

 

A Call for Industrialization

May we say of what was said above on industrial export-oriented economies that can exercise sovereignty in their economic policy in the face of speculative capital, a call for industrialization?

“Of course, this is what I’m aiming at,” answers Dr. Hamade, explaining that “in the long term, you have to build an economy;” meaning a productive, robust economy that is necessarily industrial.  “As long as you have no (such) economy, you’ll be vulnerable towards outside changes.”  According to Dr. Hamade, the bottom-line is: “If you don’t want to import others’ problems, you have to build a strong economy. When you have a healthy economy, you can afford to raise interest rates, and you would have more sovereignty in your fiscal and monetary policies. A strong economy gives you autonomy, as opposed to an import-based economy.”

 

 

Monetary Policy Alternatives

How can developing and emerging economies’ dependence on “hot money” be broken, in planning a comprehensive developmental policy? Or rather, what are the alternatives to speculative capital financing? Would these be the “good old” state-owned investment banks?

“Of course, there’s a role for the state to play. Investment banks in agriculture and industry are very important to subsidizing investment, and targeting specific types of investment, in specific regions,” Dr. Hamade affirms, saying that had it not been for the state’s central role, “Korea wouldn’t have become Korea,” citing specifically the South Korean government’s heavy subsidization of export, even to the point of Dumping, as was the case of Hyundai car sales in the US, in the phase of nurturing the then-infant Korean car industry.

 

Buttressing Local Currencies

Due to the high risks and costs entailed by the prevalent global monetary system, China and several emerging economies around the world, most prominent of which are Russia and India, had for years been seeking to build an alternative monetary architecture that would better accommodate their mutual interests. Most significant of all, perhaps, are the bilateral agreements on trade, especially of strategic goods, namely oil and gas, in the national currencies of these trade partners. Another aspect of such enterprises is the amassment of physical gold, mostly by China, and the exchangeability of the Yuan for gold on at least two Chinese platforms, one of which is the Shanghai platform. Are we witnessing the birth of an alternative global monetary system?

“Again, concerning the stabilization of a currency’s exchange rate, I’m for a robust economy supporting a national currency, and not the opposite,” reiterates Dr. Hamade, asserting that it is “impossible to go back to the gold standard, as that would mean the end of monetary policy. You wouldn’t be able to issue currency except in as much as you have gold, and the value of the currency would be fixed in terms of gold. This incentivizes you to export to get gold (or foreign exchange to buy gold with),” says Dr. Hamade, citing the abolition of the US’s former gold standard.

What path then might sovereign governments take, in an effort to stabilize their currency? “Building a stable and strong export economy” with a “managed floating exchange rate,” answers Dr. Hamade, adding that bilateral trade treaties in local currencies “would give the trading partners’ currencies some stability, since demand for these currencies would increase; but the overall stability of these currencies is also affected by other parties’ actions: an appreciation of the dollar would (still) mean automatic relative depreciation of those trading partners’ currencies.”