THE OUTLOOK
Updated September 30, 2012, 10:15 p.m. ET
Fed Move Could Aid Emerging Markets
By ALEX FRANGOS
The Federal Reserve's quantitative-easing program is unpopular across most emerging markets, but the latest round should prove far less contentious than earlier ones.
Looking beyond the Fed-bashing rhetoric that has become a habit as much in Brasilia and Beijing as in some corners of Washington, today's global economic fundamentals suggest there will be a different outcome from the U.S. bond-buying program, known as QE3.
That isn't stopping complaints that the Fed's actions will flood the world with too much capital.
"The rise in global liquidity could lead to rapid capital inflows into emerging markets including South Korea and China and push up global raw-material prices," said Bank of Korea governor Kim Choong-soo last week. "Therefore, Korea and China need to make concerted efforts to minimize the negative spillover effect arising from the monetary policies of advanced nations."
Emerging-market leaders lament that all the new money created by the Fed debases the dollar's value and makes their economies less competitive. They also say it puts upward price pressure on food and energy commodities. And they say all that new cash can build into an uncontrollable and financially destabilizing wave of money as it seeks higher returns in relatively stronger economies in Asia and Latin America.
In 2010 and again recently, Brazilian finance minister Guido Mantega accused the Fed of starting a "currency war." In the wake of QE2, in September 2010, Russia's then President Dmitry Medvedev pushed the Group of 20 to get the Fed to consult other countries before making major policy decisions. Chinese President Hu Jintao urged Washington to follow "responsible policies" and maintain a stable dollar.
The Fed has countered that a healthy U.S. recovery helps the global economy, and thus other central bankers shouldn't be so quick to criticize. Moreover, the Fed has argued that these countries could address inflation themselves if they wanted to, for instance by allowing their currencies to appreciate.
"The two-speed nature of the global recovery implies that different policy stances are appropriate for different groups of countries," Mr. Bernanke said in November 2010.
While attracting capital is usually something economies want, too much of a good thing can cause problems. A surfeit of capital can end up in bubble-prone markets such as real estate and commodities, stoking inflationary pressures. Rapid inflows of cash send currencies skyrocketing, snuffing out export competitiveness. Some worry that money that flows in quickly can also flow out quickly, whipsawing businesses and banks.
QE2, launched in November 2010, was a particular problem because the global economy at the time wasn't in sync. The U.S. was sputtering while places like Asia and Latin America were booming, which meant much of those new dollars flowed to the high-growth areas of the world, be it Indonesian bonds, Singapore real estate or Brazilian stocks.
That made things very complicated for emerging-market central bankers. The usual remedy for fighting inflation, to lift interest rates, would make things worse by attracting even more capital. Left unchecked, the inflows would put pressure on currencies to rise further in economies such as South Korea and Taiwan, where exports make up a large part of their economic growth.
In the aftermath of QE2, central banks in emerging markets did lift rates reluctantly, and ameliorated the inflows with massive currency-intervention programs, restrictions on capital flows, and vociferous diplomacy directed at the Fed. Emerging-market currency reserves rose 50% since the global financial crisis ebbed in 2009 and are now over $7 trillion.
With QE3, the reaction has been more muted. Asian and Latin American central banks, despite hemming and hawing, are in policy concert with the Fed's actions. Economies are ailing and central banks are cutting rates, more worried about growth than inflation. Countries like Indonesia and China have seen capital outflows this year, and the Fed's latest move could help refill the financial system.
In essence, emerging markets are rowing in the same direction as the Fed, loosening policy at the same time. As interest rates fall everywhere, the effect on currencies is subdued, so central banks feel less pain.
"The emerging-market central banks had good reason to complain last time," says Tim Condon, economist for ING in Singapore. "All they got out of it was a sugar high." This time, he says, "fears about a repeat are misplaced."
For emerging economies that still turn to the U.S. as their top customer, what will make QE3 popular in the end is if it works to get the world's largest economy humming again.
Looking beyond the Fed-bashing rhetoric that has become a habit as much in Brasilia and Beijing as in some corners of Washington, today's global economic fundamentals suggest there will be a different outcome from the U.S. bond-buying program, known as QE3.
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When the Fed launched an earlier bond-buying program in 2010, many of these emerging markets were preoccupied with controlling inflation and felt threatened by Fed efforts to spur growth. With these emerging markets now suffering their own growth ills, Fed stimulus has the potential to help, not hurt.
That isn't stopping complaints that the Fed's actions will flood the world with too much capital.
"The rise in global liquidity could lead to rapid capital inflows into emerging markets including South Korea and China and push up global raw-material prices," said Bank of Korea governor Kim Choong-soo last week. "Therefore, Korea and China need to make concerted efforts to minimize the negative spillover effect arising from the monetary policies of advanced nations."
Emerging-market leaders lament that all the new money created by the Fed debases the dollar's value and makes their economies less competitive. They also say it puts upward price pressure on food and energy commodities. And they say all that new cash can build into an uncontrollable and financially destabilizing wave of money as it seeks higher returns in relatively stronger economies in Asia and Latin America.
In 2010 and again recently, Brazilian finance minister Guido Mantega accused the Fed of starting a "currency war." In the wake of QE2, in September 2010, Russia's then President Dmitry Medvedev pushed the Group of 20 to get the Fed to consult other countries before making major policy decisions. Chinese President Hu Jintao urged Washington to follow "responsible policies" and maintain a stable dollar.
The Fed has countered that a healthy U.S. recovery helps the global economy, and thus other central bankers shouldn't be so quick to criticize. Moreover, the Fed has argued that these countries could address inflation themselves if they wanted to, for instance by allowing their currencies to appreciate.
"The two-speed nature of the global recovery implies that different policy stances are appropriate for different groups of countries," Mr. Bernanke said in November 2010.
While attracting capital is usually something economies want, too much of a good thing can cause problems. A surfeit of capital can end up in bubble-prone markets such as real estate and commodities, stoking inflationary pressures. Rapid inflows of cash send currencies skyrocketing, snuffing out export competitiveness. Some worry that money that flows in quickly can also flow out quickly, whipsawing businesses and banks.
QE2, launched in November 2010, was a particular problem because the global economy at the time wasn't in sync. The U.S. was sputtering while places like Asia and Latin America were booming, which meant much of those new dollars flowed to the high-growth areas of the world, be it Indonesian bonds, Singapore real estate or Brazilian stocks.
That made things very complicated for emerging-market central bankers. The usual remedy for fighting inflation, to lift interest rates, would make things worse by attracting even more capital. Left unchecked, the inflows would put pressure on currencies to rise further in economies such as South Korea and Taiwan, where exports make up a large part of their economic growth.
In the aftermath of QE2, central banks in emerging markets did lift rates reluctantly, and ameliorated the inflows with massive currency-intervention programs, restrictions on capital flows, and vociferous diplomacy directed at the Fed. Emerging-market currency reserves rose 50% since the global financial crisis ebbed in 2009 and are now over $7 trillion.
With QE3, the reaction has been more muted. Asian and Latin American central banks, despite hemming and hawing, are in policy concert with the Fed's actions. Economies are ailing and central banks are cutting rates, more worried about growth than inflation. Countries like Indonesia and China have seen capital outflows this year, and the Fed's latest move could help refill the financial system.
In essence, emerging markets are rowing in the same direction as the Fed, loosening policy at the same time. As interest rates fall everywhere, the effect on currencies is subdued, so central banks feel less pain.
"The emerging-market central banks had good reason to complain last time," says Tim Condon, economist for ING in Singapore. "All they got out of it was a sugar high." This time, he says, "fears about a repeat are misplaced."
For emerging economies that still turn to the U.S. as their top customer, what will make QE3 popular in the end is if it works to get the world's largest economy humming again.
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