November 4, 2010
Emerging markets criticized the Federal Reserve for its decision to pump more money into the U.S. economy, known as Quantitative Easing 2, a measure that they fear could escalate the worrisome flood of cash into fast-growing economies. Officials from countries like Brazil and Thailand threatened more measures to curb the flood of money that has pushed up currency values and fueled concerns that asset price bubbles might be in the making.
While long-term investments, are welcome ways of bolstering economic development, the capital influxes into emerging market stocks, bonds and property have increased rapidly in recent months, totaling more than $2 billion a day, according to estimates by DBS in Singapore.
The Fed said it will buy $600 billion of Treasuries between now and next June, at about $75 billion a month, although it also said it could adjust the amount and timing if need be. That was about what markets expected but far less than the $1.75 trillion of debt it bought between early 2009 and early 2010 in its first round of quantitative easing. Yet the second round of quantitative easing seems already to have exceeded the low expectations it has aroused. Since Ben Bernanke, chairman of the Fed, hinted at it at Jackson Hole on August 27th, markets have all done exactly what they should.
Under the decision to pump more money into the U.S. economy the Fed buys long-term bonds with newly created money. This lowers long-term yields and chases investors into riskier, alternative investments. The real yield on ten-year, inflation-indexed Treasury bonds has fallen from 1.05% to 0.5%, a result of relatively flat nominal yields and a rise in expected inflation. The yield on their five-year cousins is negative. Share prices are up by 14% in the same period. Lower yields make the dollar less appealing: it has duly fallen by 5% against the Japanese yen, by 9% against the euro and by 5% on a trade-weighted basis.
With a bit of a lag, these easier financial conditions are supposed to boost growth through three channels. First, lower real yields spur borrowing and investment. This channel is bunged up: many households cannot borrow because their homes have fallen in value and because banks are less willing to lend. But the remaining two channels remain open. Higher share prices have raised household wealth by some $1.4 trillion, which will spur some spending. And the lower dollar should help trade. American factory purchasing managers reported a sharp jump in export orders in October and a drop in imports.
Other countries complain that the Fed pumping more money is merely bringing them overvalued currencies and bubbly asset markets by pushing investors to seek higher returns elsewhere. But that may be unavoidable given their divergent growth paths. Both India and Australia raised interest rates this week despite rising currencies.
Many emerging-market countries and Japan have been intervening in the foreign exchange markets in an effort to slow the rise in the values of their currencies, which they fear could harm export industries by making exported goods and services more expensive for overseas consumers.