US allies take hit from QE2 By Peter Lee| November
13, 2010
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$650 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 $650 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.
But explicitly selfish, beggar-thy-neighbor behavior is
not one of the privileges of US global leadership - and
declining to do the heavy lifting of stimulating global
economic demand is not part of the job description of the
creator of the world's reserve currency.
Lowering America to China's level leaves an implicit leadership
vacuum in the global financial system.
It was a void that Robert Zoellick, head of the World Bank,
was willing to acknowledge with a much-mocked (in the United
States) suggestion that gold - whose supply is less subject
to the vagaries of American domestic policy than the greenback
- might be included in new "Bretton Woods II"
international currency system. [9]
That puts Zoellick on almost the same page as maverick
US economist Joseph Stiglitz, who wants to elevate the Special
Drawing Rights of the International Monetary Fund (IMF)
to the role of the global reserve currency in order to protect
smaller nations from dollar shock as the US diddles its
currency in order to pursue domestic economic policies.
The Petersen Institute for International Economic's Arvind
Subramania ,while acknowledging that the United States as
well as China has decided to "debauch" (his words)
its currency, voiced the rather forlorn hope that QE2 would
inspire the nations of the world to gang up on China at
the G-20 summit in Seoul this week, in a virtuous kind of
way:
With Japan and the European Union now more vocal about
the yuan, the US could achieve a critical diplomatic mass
if it can persuade, say, Brazil, Mexico, India, South Africa,
and South Korea to form this coalition. Once political agreement
is secured at the G-20, implementation can be left to the
IMF or the World Trade Organization or a combination of
both as Aaditya Mattoo of the World Bank and I have proposed.
Multilateralism - with a more prominent role for emerging-market
countries - is essential now to prevent competitive currency
debauchery by China and the United States from blowing up
the system. [10]
A more likely predictor of who will be ganging up on whom
is provided by the press release from the US Bureau of Economic
Analysis on America's August 2010 goods trade deficit:
The August figures show surpluses, in billions of dollars,
with Hong Kong $1.9 ($1.8 for July), Singapore $1.1 ($1.2),
Australia $1.0 ($0.9), and Egypt $0.4 ($0.4).
Deficits were recorded, in billions of dollars, with China
$28.0 ($25.9), OPEC $9.0 ($8.0), European Union $8.1 ($9.9),
Mexico $6.0 ($5.3), Japan $5.8 ($4.9), Germany $3.4 ($3.6),
Nigeria $2.7 ($2.4), Ireland $2.5($2.4), Venezuela $2.2
($1.8), Canada $2.2 ($1.4), Korea $1.3 ($1.0), and Taiwan
$1.2 ($1.0). [11]
Add the Organization of Petroleum Exporting Countries,
the European Union, Mexico, Japan, Canada, Korea, and Taiwan
- and many more - to the list of countries and groupings
in addition to China upon whom the US declared virtual currency
war with QE2.
It might also be pointed out that many of these countries
would have remained securely in the US camp if the United
States had stuck to a (very popular) position of coordinated
multi-lateral whining about the Chinese exchange rate, ensuring
that, if China did revalue, alternate exporters, primarily
in Asia, would have profited (before American industries)
from a shift in sourcing.
Instead, quantitative easing threatens to yank the terms
of trade back in America's favor at the expense both of
China and of many of the free-market exporters who sell
to the US.
Inadvertently or not, the QE2 message seems to be that
resolute diplomatic support of the United States in its
dust-up with China will not necessarily be rewarded with
the fruits of mercantilist victory for its allies.
QE2 fallout will probably exacerbate America's difficulties
in cobbling together a united front on currency issues at
the G-20 summit in Seoul (a final communique was expected
at this article went to publication).
Treasury Secretary Timothy Geithner's proposal for a grand
bargain - a shared commitment by the major nations to limit
their trade surpluses/deficits to 4% of GDP - was perhaps
a commendable effort to move beyond yuan currency-bashing
to address fundamental trade issues in a positive way.
However, it appears doomed by the lack of any commitment
to limit national government budget deficits - the "accounting
identity”, the yin to the trade deficit's yang, that
so beguiles economists - as a percentage of GDP.
For those of you keeping score, EU guidelines call for
budget deficits not to exceed 3% of gross domestic product
(GDP), a level that China pretty much meets (perhaps 3.5%)
- the actual level for the EU 27 countries last year was
6.8%. [12]
The United States, on the other hand, with $1.5 trillion
in deficit spending projected for 2010, weighs in at an
unappetizing 10.64% deficit to GDP ratio in 2010. With total
indebtedness of $13 trillion, the overall US indebtedness
to GDP ratio is 100%; only Japan, Italy, and Greece join
the US in the triple-digit club among the major economies.
(To be fair, in a sign of big troubles down the road, China's
local governments have piled up mountains of unsustainable
debt that, if included in national figures, may push China's
indebtedness ratio up in the 90s as well). [13]
Loyalty, tactics, and outlook may have gone some way to
preserving the semblance if not substance of joint action
against China at the G-20 summit in Seoul. However, China
has made it clear it won't yield to any pressure on revaluation
of its currency. In meeting with President Obama on Thursday
before the summit, Chinese President Hu Jintao reiterated
that reform on yuan exchange rate mechanism "needed
a favorable external environment, and could only be advanced
gradually". The People's Daily reported the meeting
with the headline: "Hu, Obama set tone for G20"
[14]
And for the smaller economies, less vested in the glories
of post-World War II/post-Cold War pre-eminence than the
United States, muddling through while a cheaper dollar erodes
their exports and inflates their asset markets is a somewhat
less enviable or inevitable alternative.
As a practical matter, most nations will be preoccupied
with concrete measures to reduce the impact of the cheap
dollar on their currencies, assets, and export markets.
Rhetoric at the summit concerning China's exchange rate
misdeeds may even be balanced by a declaration of principles
deploring currency devaluations.
As for China, it has found itself in the unexpected and
welcome position of lecturing the United States how a superpower
discharges its financial and economic obligations. Zhu Guangyao
weighed in QE2 at a press conference in Beijing on November
9:
"The current situation is totally
different from the time of the first round. There's no shortage
of funds in the financial market," Zhu said.
He urged the United States to "realize its responsibility
and obligation as a major currency issuing country, and
take responsible macroeconomic policies". The communique
of the meetings of G-20 finance ministers and central
bank governors has stressed that countries with systemic
influence should pay attention to the "spillover
effect" of their macroeconomic policy.
As the recovery of world economy is still unstable, a
responsible macroeconomic policy will not only be good
for the United States, but also the world as a whole,
the vice finance minister said. [15]
China presumably has a strategy to deal
with the opportunities that QE2 presents. Perhaps Beijing
will exploit the difficulties of its neighbors by reaching
out to selected countries bilaterally in order to convince
them of the wisdom of working with China economically while
drifting away from the US on matters of security.
In Japan, the presumed bulwark of US interests in the Pacific,
Prime Minister Naoto Kan is demonstrably unhappy with the
anti-China role thrust upon him by Foreign Minister (and
pro-US China hawk) Seiji Maehara. Prepping for the G-20
confab in Seoul, Kan gave an interview to the Wall Street
Journal on November 8:
Prime Minister Naoto Kan joined the growing
chorus of world leaders complaining about the side effects
of American economic policy, tying the Japanese yen's strength
to Washington's aggressive stimulus efforts - and implying
that the US should be accepting of Japan's own controversial
moves to halt the yen's rise.
"First and foremost, one of the biggest reasons
for the yen's rise is the dollar's weakness, a reflection
of America's economic policy. We need for there to be
a clear understanding of that background," he said
in an interview with The Wall Street Journal Saturday.
He added: "President Obama has said the US wanted
to shift its economy from one driven by consumption to
one that relies more on expansion of exports. We do recognize
that basic policy. But there are reverberations of that
policy on Japan."
…
Asked to reflect on the chill that has come over China-Japan
relations since the collision [involving a Chinese trawler
and a Japanese coastguard vessel], the prime minister
made only the most indirect criticism of what many Japanese
and US officials have called China's heavy-handed response
to the incident, saying: "As far as China's various
actions go, it wields enormous economic power, so as a
major world player we want the Chinese to act in accordance
with global rules, and that's our basic expectation of
China."
Kan also predicted that ... mutually beneficial interests
would lead to an improvement in ties with Beijing. "In
due time, we'll see a return to the stable relationship
we had previously," he said. [16]
What the world needs now, to paraphrase
Burt Bacharach, is stimulus, sweet stimulus.
As Joseph Stiglitz put it:
The answer to this seeming stalemate is simple: resume
global growth, and appreciation of the currency will naturally
follow. Restoring growth requires that all governments
that have the capacity to expand aggregate demand do so.
The US has a special responsibility, both because of its
culpability in creating the global crisis and because
it can borrow at low interest rates, an advantage partly
derived from its status as the de facto reserve currency.
This is the time for the US to make the high productivity
investments it needs. [17]
And China is a key stimulus player. In a remarkably laudatory
piece, Reuters' Alan Wheatley wrote on November 9:
According to the IMF, the global economy
grew just 0.19% last year, measured in terms of purchasing
power parity.
China, expanding nearly 10 times faster, contributed
1.19 percentage points to that growth.
In short, it really did save the world from recession.
[18]
Instead, it looks like what the world is
getting is fear, uncertainty, doubt, hesitant and equivocal
moves toward competitive devaluation, and a spasm of fingerwagging
at China.
With quantitative easing, it appears that the United States
has squandered its most precious asset - the mantle of global
financial leadership - to the dismay and confusion of its
allies.
It is difficult to envisage a situation in which the nations
of Asia, South America, and Europe, demoralized by unilateral
American fecklessness, unite to negotiate a positive and
productive Chinese role in ameliorating the grinding global
recession.
Predictions of economic Armageddon are usually exaggerated.
However, without the ability to offer China positive incentives
to assume the onerous and politically and economically risky
role of global stimulus engine, the more likely prognosis
for the world seems to be austerity, devaluation, capital
controls, and beggar-thy-neighbor economics.
Notes
1. Capital controls eyed as global currency wars escalate,
Telegraph, Sep 29, 2010.
2. China Says Flood of Dollars Could Spark New Crisis, ABC,
Nov 4, 2010.
3. Emerging powerhouses vow action after Fed's bond move,
China Economic Net, Nov 5, 2010.
4. China Says Fed Easing May Flood World Economy With ‘Hot
Money', Business Week, Nov 8, 2010.
5. CPI hits new high with 4.4% increase, People's Daily,
Nov 12, 2010.
6. Quantitative easing: printing money like mad to ward
off deflation, Roubini, Dec 1, 2008.
7. Global Fed bashing casts shadow over G-20, CNN, Nov 8,
2010.
8. QE Is Not CM, New York Times, Nov 8, 2010.
9. Zoellick: I'm No Goldbug, Wall Street Journal, Nov 10,
2010.
10. America Cannot Win the Currency Wars Alone, Oct 20,
2010.
11. U.S. Bureau of Economic Analysis - News, BEA, Nov 10,
2010.
12. Euro area and EU27 government deficit at 6.3% and 6.8%
of GDP respectively, Eurostat, Apr 22, 2010.
13. China's Hidden Debt Risks 2012 Crisis, Northwestern's
Shih Says, Bloomberg, Mar 2, 2010.
14. Hu, Obama set tone for G20, People's Daily, Nov 12,
2010.
15. China shows concern, questions over U.S. new monetary
policy, People's Daily, Nov 9, 2010.
16. Japan's Leader Bemoans Impact of U.S. Economic Policy,
Wall Street Journal, Nov 8, 2010.
17. A currency war has no winners, Guardian, Nov 1, 2010.
18. World looks to China after growth-salvaging stimulus,
Reuters, Nov 9, 2010.
Peter Lee writes on East and South Asian affairs and
their intersection with US foreign policy.