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     Nov 13, 2010

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US allies take hit from QE2
By Peter Lee

With one desperate economic measure - the second quantitative easing or QE2 - the United States threatens to undo many of its victories won in its campaign to "Return to Asia" and reassert America's place at the heart of the Asian diplomatic, security, and military equation.

Many of America's allies, friends, and acquaintances in the region are being pummeled by the weakening US dollar, as is the designated competitor - and most likely target - China.

But China, by virtue of its rather closed financial markets, managed currency, rigid political controls, and acknowledged strategic rivalry with the United States, is probably better equipped to withstand the pressure of a devaluing dollar than the


free-market nations that are America's allies.

Even before US Federal Reserve chairman Ben Bernanke announced that the US government would put US$600 billion in cash in the capital markets through the purchase of Treasuries, the currencies of most exporting countries had appreciated significantly against the US dollar, over 10% for most, with Brazil's real strengthening 35% in 2009.

In the UK, The Telegraph, no friend of quantitative easing, documented the atrocities on September 29:
Guido Mantega, the Brazilian Finance Minister, said an international currency war threatened the country's competitiveness.

Mexico, Peru, Colombia, Korea, Taiwan, South Africa, Russia and even Poland are either intervening directly in the exchange markets to prevent their currencies rising too far, or examining what options they have to stem disruptive inflows.

Peter Attard Montalto from Nomura said quantitative easing by the US Federal Reserve and other central banks is incubating serious conflict. "It is forcing money into emerging market bond funds, and to a lesser extent equity funds. There has truly been a wall of money entering many countries," he said.

"I worry that we are on the cusp of a competitive race to the bottom as country after country feels they need to keep up." [1]
The anxieties have continued into early November, as AP reported:
China's stock market reached a seven-month high Thursday, and South Korea's benchmark KOSPI index was close to a three-year high. India's market is flirting with an all-time record and some markets including Indonesia and the Philippines have been setting record highs nearly daily.

In the Philippines, where capital inflows have surged this year, the central bank said Thursday it would "remain vigilant" about the possible impact of the Fed's action.

Last month, Thailand imposed a tax on income foreigners can earn from bonds in hopes of discouraging an influx of money that has pushed its baht to a 13-year high against the dollar.

In the Philippines, the influx of short-term "hot money" in the first nine months of the year jumped 300% from a year earlier to $1.8 billion, according to the central bank. [2]
China Economic Net was there to relay the grim news after QE2 was officially announced:
Policymakers from the world's new economic powerhouses in Latin America and Asia pledged yesterday to come up with fresh measures to curb capital inflows after the United States Federal Reserve said it would print billions of dollars to rescue its economy.
South Korea's Ministry of Finance and Strategy said it had sent "a message to the markets" yesterday and would "aggressively" consider controls on capital flows, while Brazil's Foreign Trade Secretary said the Fed's move could cause "retaliatory measures."

Economy Minister Ali Babacan of Turkey, where the central bank has been buying increasing amounts of foreign exchange in an effort to curb appreciation of the lira against the dollar, said the Fed's action might backfire.

"The Fed move was a measure taken in a desperate environment. It should be considered whether pumping this much money into the market can create more damage than benefit," he said.

Thailand raised the possibility of concerted action to combat the flood of investment dollars that are expected to wash into emerging markets.
Zeti Akhtar Aziz, head of Malaysia's central bank, also said Asian central banks were "willing to act collectively if the need arises to ensure stability in the region."

A senior Indian finance official .... said that while the US had a right to stimulate its own economy, others would also serve their own interests and said that any deal on currencies in Seoul had to be a "win for both the blocs." [3]
For good measure, here's Business Week on November 8:
"Around the world we have $10 trillion of hot money flowing around, more than the $9 trillion in hot money at the beginning of the global financial crisis," [Chinese Vice Finance Minister Zhu Guangyao] said. The US "has not fully taken into consideration the shock of excessive capital flows to the financial stability of emerging markets."
German Finance Minister Wolfgang Schauble compared the Fed move to China's currency policy, which involves hundreds of billions of dollars in U.S. dollar purchases to prevent rapid appreciation of the yuan. "The instruments are different but the goal is the same," he said in a Nov 5 speech in Berlin.

"This is a U.S. countermove in the global beggar-thy- neighbor process," said Michael Pettis, a finance professor at Peking University and a former managing director at Bear Stearns Cos. [4]
On Thursday, China's National Bureau of Statistics (NBS) said the consumer price index (CPI), a main gauge of inflation, increased 4.4% year on year in October, 0.8 percentage point higher compared to September's 3.6%. Chinese officials blame "the effective devaluation of the US dollar as a result of quantitative easing" as partially responsible for China's inflation hikes, as the "weak dollar pushes up commodity prices, which, through international trade, affects prices in China." [5]

The only country that seems to be completely happy with the current state of affairs is Australia, which sees the prices of its export resources exploding together with its currency, which recently broke parity with the dollar.

With reduced interest rates and further dollar devaluation seen as the most important effect of quantitative easing, nations hoping to export their way out of the recession face a triple economic burden.

First, the weakening dollar will drive speculative inflows to overseas assets, with the potential for inflating stock market and real estate bubbles.

Second, the United States is looking to position itself as a growing exporter on the back of its depreciated currency - and a stronger international competitor, particularly against the EU.

Third, US international purchasing power declines with the dollar, reducing its role as an export destination.

The biggest burden, however, may be psychological. The United States appears to be surrendering its post-World War II role as the last-resort generator of global demand and redefining itself as just another anxious exporter. It might be said that the QE2 itself is the first export of this new regime. Indeed, QE2 was "Made in America", a product of American political conditions.

The US recovery is faltering, thanks to an inadequate stimulus. After the midterms, an adequate stimulus is off the table.

The Republican majority in the House of Representatives has taken a position against further stimulus spending as a matter of ideology, electoral politics, and, one would suspect, a cynical willingness to see the US economy go down in flames, as long as President Barack Obama's hopes for a second term go with it.

With fiscal policy ruled out, monetary policy is the only lever accessible to the president to create jobsjobsjobs and votesvotesvotes.

Conventional monetary policy - driving down interest rates to near zero - hasn't restored bank lending and economic activity to a nation still working its way out from under a mountain of personal and corporate debt.

Which leaves unconventional monetary policy or "quantitative easing" - increasing the supply of money ex nihilo, from nothing, and hoping something good comes of the inflation and inflationary expectations it engenders.

However, it will be interesting to people who learned about the multiplier effect of fractional reserves in college economics classes that the famous multiplier doesn't seem to work in situations like this. [6]

Instead of the $600 billion in cash racing through the economy and stimulating trillions of dollars of domestic lending, it will probably land with a dull thud on the balance sheets of the big money center banks, to be shoveled up and tossed into the maw of emerging overseas markets instead.

The dollar inflows translate into higher exchange rates and reduced exports.

And it is crappy politics, especially for the allies who have been holding the free-market/globalization line together with the United States to criticize China's currency policies, as CNN reported on November 8:

The harshest criticism came Friday from German Finance Minister Wolfgang Schauble, who told reporters at a conference that, "With all due respect, US policy is clueless. ... It's not that the Americans haven't pumped enough liquidity into the market. Now to say let's pump more into the market is not going to solve their problems."

Schauble went further in an interview with the German magazine Der Spiegel in which he said the Fed's move undercuts efforts by the United States and Europe to get the Chinese to allow its currency to rise in value.

"It's inconsistent for the Americans to accuse the Chinese of manipulating exchange rates and then to artificially depress the dollar exchange rate by printing money," he said in the interview.

South African Finance Minister Pravin Gordhan, a prominent voice among finance officials from emerging economies, said the Fed's move was disappointing because it undermines the spirit of multilateral cooperation that is the reason for holding Group of 20 meetings.

He said top finance and central bank officials agreed only recently that "given the high interdependence among nations in the global economic and financial system, uncoordinated responses would lead to worse outcomes for everyone." [7]

The Obama administration appears to be aware of this public relations conundrum. It is therefore loathe to acknowledge that the key motive of QE2 is a de facto devaluation of the US currency, one that will diminish the US trade deficit and generate export oriented jobs and economic growth for the US.

Nobel economics prize winner and New York Times columnist Paul Krugman, a vociferous advocate of confronting China on the currency issue, indignantly rejected any suggestion of equivalence between China's currency policies and US quantitative easing:

China is engaged in currency manipulation, that is, buying foreign currency to keep the yuan weak; meanwhile, it is actually moving to reduce domestic demand, among other things raising interest rates.

So the United States is moving to expand world demand, with a policy that may weaken the dollar; China is moving to reduce world demand, with a policy of deliberately weakening the yuan. America's policy may annoy its trading partners, but they are not the target; China's policy is predatory, pure and simple. No equivalence here. [8]

However, judging by effects as perceived by finance ministers, rather than intentions as divined by Krugman, QE2 looks, walks, and quacks a lot like a devaluation. So it looks like the US is out for itself, competing for a share of the pie while doing nothing to grow the pie.

Continued 1 2  

G-20 on collision course (Nov 10, '10)

Geithner's hidden G-20 agenda (Oct 27, '10)




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