US allies take hit from QE2 - Asia Times Online Asian news and current affairs

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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$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.

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US allies take hit from QE2
By Peter Lee

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.

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