QE Proving a Success But Emerging Markets Respond

Andy Lees of UBS writes that quantitative easing is having the (designed) effect of diluting and transferring US debt elsewhere. It is already a success. In a morning note he tells us:

Yesterday Saudi shifted its oil price target upwards. In 2008 it announced a USD400bn 5 year plan, which according to the Centre for Global Energy Studies raised the breakeven level for its budget from around USD40bbl to around USD74bbl. In 2009 it overspent by 26%, posting a deficit of 6.2% GDP. In early October Saudi’s finance minister said public expenditure would be higher than had been budgeted for but said it was too early to state whether this would result in a deficit. "The higher spending does not seem to be moderating and 2011 will be characterised by another expansionary budget" according to Banque Saudi Fransi.

Isn’t this an indication that QE is working perfectly? The objective of this kind of stimulus must be to dilute and transfer US debt. By ramping up commodity prices, the US is boosting the commodity country’s purchasing power, and they are spending this increased wealth exactly as would be expected.

Lees also mentions the massive $60 billion arms deal that the US recently announced with Saudi Arabia as a way to shift the burdens elsewhere. Andy says the point is that the Saudis are spending in large part because QE has debased the US currency, increasing commodity prices, benefitting the Saudis.

He mentions a similar dynamic in the emerging markets during the 1970s when those economies spent heavily, increasing their standards of living but taking on large quantities of debt. Meanwhile in the US, debt burdens were inflated away. However, the problem during that episode was how it ended in crisis when Paul Volcker increased interest rates in the U.S. The Latin American debt crisis ensued plunging the area into a depression and creating solvency problems for American lenders. 

This is exactly why emerging markets are erecting capital controls today. The U.S. is caught in debt deflationary dynamics and has decided to print money to ward of this deflation. The Fed can print, but cannot direct where the liquidity winds up. When investments are more attractive elsewhere, the printed money ends up there; The Fed has effectively exported its inflation. Emerging markets are looking to prevent this inflationary policy of the Fed from creating an unsustainable rise in asset prices and the concomitant rise in debt that often accompanies it. After the Fed announcement, a number of emerging market countries voiced concern and vowed to fight this. Reuters reports:

Emerging economies expressed displeasure at the Fed’s move, making any substantive deal on global imbalances and currencies at next week’s Group of 20 meeting in Seoul even less likely.

"As long as the world exercises no restraint in issuing global currencies such as the dollar — and this is not easy — then the occurrence of another crisis is inevitable, as quite a few wise Westerners lament," Xia Bin, an advisor to China’s central bank wrote in a newspaper managed by the bank.

South Korea’s Ministry of Finance and Strategy said it had sent "a message to the markets" on Thursday 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.

"The central bank governor has confirmed discussions with central banks of neighboring countries, which are ready to impose measures together if needed to curb possible speculative money flowing into the region," Finance Minister Korn Chatikavanij told reporters.

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.

Who’s the bad guy, now?

Source: Emerging market policymakers vow to combat Fed’s QE2 – Reuters

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