Does the world need more QE from the Fed?
- Kathleen Brooks is research director at forex.com. The opinions expressed are her own -
The minutes from the Federal Reserve’s September meeting seems to suggest that more quantitative easing is a done deal for November. So far, the argument has centred on whether or not the U.S. economy needs another shot in the arm from the Fed to boost growth. The Fed certainly thinks it does. According to the minutes “many” members felt that the status quo – sluggish growth, inflation grinding lower and no sign of a recovery in the jobs market – was enough to justify more easing in policy.
These are pretty compelling reasons for more QE to stimulate the flagging U.S. economy, but what about the rest of the world? Any action by the Fed has huge implications for the global economy. Usually, when the Fed shifts its stance from easing to tightening or vice versa it starts a global chain reaction.
But now that we are in unusual times, the Fed’s actions are even more important. Turning on the printing presses will have three main consequences. Firstly, it may not have the desired effect on the U.S. economy. If it doesn’t make companies hire more staff, and corporations continue to sit on huge cash piles, then the liquidity generated by the Fed will start to seep out of the US economy.
If you can borrow cheaply but don’t want to expand your business, perhaps because you don’t have strong enough faith in U.S. householders who are busy retrenching and paying off debt rather than spending, then you’ll chase returns elsewhere. This will create liquidity bubbles. The immediate beneficiaries will be stocks and commodities. We have already seen gold reach new highs, and equities are looking like they are popping up. It’s great if you are at the receiving end of the liquidity, however if you are not, then you’ll be left out in the cold.
If the U.S. doesn’t boost demand with more QE, then domestic retailers will soon feel the chill of prolonged high unemployment. Likewise, if the money chases investments in high-growth economies, then it will leak to emerging markets, by-passing the sluggish, debt-laden west.
Capital inflows to emerging markets is what is fuelling the so-called “currency war”. While capital flows will put upward pressure on local currencies across emerging economies, the market hasn’t been focusing on the real problem – the prospect of Fed money fuelling the next financial bubble. In this sense, authorities including Brazil and Thailand who have imposed capital rules to try and stem the flow of money into their asset markets, have done not only to keep their export markets competitive, but also to prevent unsustainable asset price bubbles.
These economies learnt harsh lessons from the Asian and Latin American financial crises of the 1990s. That is why the U.S. should consider the implications of turning on the printing presses, and ensure that the extra money it produces targets the real problem: how to ignite U.S. demand.