Diverging monetary cycles

Horizons article
May 5, 2023

In this Horizons, we look at the desynchronized monetary cycle. At this time, the West is at the end of the monetary easing cycle, whereas the flexibility of emerging countries has remained relatively high.

Belt-tightening in developed countries

After a prolonged period of low interest rates, Western countries are at the end of the monetary easing cycle, and this has financial, political, and socio-cultural consequences. A sector that experiences the consequences of rising interest rates first hand is banking. Because of their low risk profile, banks often invest in government bonds. With interest rates rising, bonds are losing value (long-term bonds lose more value than shorter-term bonds), leading to capital losses at banks, with SVB and Signature Bank as extreme examples. The higher interest rate will also cause problems for Western public finances. As a result, spending cuts will increasingly be on the political agenda, as we already see in the United States, the United Kingdom, Germany, France and the Netherlands. These cuts will ultimately affect citizens – who already suffer from higher prices because of inflation – potentially resulting in increasing dissatisfaction and social unrest. Recent strikes, such as airport strikes in Berlin, public transport strikes in the Netherlands, and healthcare strikes in Spain, the UK, and the Netherlands, are an indication of what might be coming.

Broadening your horizons
  • The BRICS might soon incorporate more countries. Bloomberg describes that nineteen countries have expressed interest in joining, including Algeria, Egypt, Indonesia
  • Democrats and Republicans in the US are approaching a standoff with major financial and political implications. The Republicans want to limit debt while cutting federal spending, whereas Joe Biden wants a debt limit hike with no strings attached.
  • A report from leftwing think-tank New Economic Foundation showed that the UK government is hiding £28bn of ‘stealth cuts’ to public services. In the Guardian, the Trades Union Congress calls on the chancellor to boost public spending to keep Britain out of a recession instead of increasing austerity.
Flexibility in emerging countries

While Western economies seem increasingly vulnerable, emerging countries are in a different phase of the monetary cycle. With relatively lower inflation, higher economic growth, and the ability to lower interest rates, some of these countries have greater flexibility to adjust monetary and fiscal policies and respond to changing economic conditions. To become less dependent on the Western financial system and its currencies, countries are applying various strategies. For instance, emerging countries are increasingly using their own currencies to conduct transactions, as China and Brazil agreed to recently. The mix of currencies in the foreign reserves of central banks is changing as well. In Brazil, for example, the yuan passed the euro to become the second most important currency (after the US dollar). Furthermore, the BRICS alliance is working on an alternative currency, and China and Malaysia discussed the potential of an Asian Monetary Fund. By reducing their dependence on Western currencies, emerging countries can improve their financial stability and protect themselves against possible economic shocks.


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