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QE2 Is Coming, To An Economy Near You

With the US economy still not quite recovering – in terms of jobs at least – there is a lot of appetite for another round of quantitative easing, or QE2. This one might go through, from an RBS list at FT Alphaville, showing that most voting members are likely to say okay to QE2.

Motley Fool says QE2 will just push money into emerging markets.

All that freshly-squeezed liquidity, at least another $1 trillion worth, plus whatever the UK chips in, will sluice through the global economy looking for the highest returns, and we know where those can be found. Emerging markets, which have consistently outperformed the West, and are expected to continue doing so.

Given low interest rates in the West and low growth prospects, the flow of liquidity into emerging markets could easily turn into a flood. Again, this has already started. While equity markets in the developed world grew a pacey 13.5% in the third quarter, emerging markets returned 17.5%. That’s hardly surprising, with Brazil offering bond yields of up to 11%. Where else would the smart money go?

This is crazy; it will fuel internal inflation because RBI is going to be panicky enough to sell rupees and buy dollars; it has already added $2.5 billion last week but then most of that could be depreciation of the dollar against the Yen/Euro/Pound which it holds.

Tim Duy makes the point that this could be the Final End of Bretton Woods 2:

The time may finally be at hand when the imbalances created by Bretton Woods 2 now tear the system asunder.  The collapse is coming via an unexpected channel; rather than originating from abroad, the shock that sets it in motion comes from the inside, a blast of stimulus from the US Federal Reserve.  And at the moment, the collapse looks likely to turn disorderly quickly.  If the Federal Reserve is committed to quantitative easing, there is no way for the rest of the world to stop to flow of dollars that is already emanating from the US.  Yet much of the world does not want to accept the inevitable, and there appears to be no agreement on what comes next.  Call me pessimistic, but right now I don’t see how this situation gets anything but more ugly.

Simply put – the Fed prints money and buys up US govt. bonds. That money, through complex channels involving the words “Bank”, “Hedge”, “Pension” and “Fund” comes into world markets, and likely emerging markets in a big way. This is way too much money so the rest of the world has two options – refuse foreign inflows by setting up massive costs for money entering the country, or buy those dollars.

The first option will induce protectionist behaviour at the other end and honestly it doesn’t work for too long in this increasingly connected world, because we still need to buy goods from abroad so we can’t really say stop investing in our country to foreigners.

The second option will involve printing local currency to buy dollars – which may at some silly level work for a short while, but because it produces massive inflation due to the sheer quantity of the money involved (the total money printed is likely to be the size of the Indian GDP) there won’t be too many options left. Therefore the local currencies will have to appreciate; which should be good specifically for India because we import so much more than we export (oil included). The problem is – will our exporters like it? Obviously not, but they are inefficient and the industry needs to change. On the flip side they’ll probably have to float the rupee and let Indian money flow out to counter the flow, which means great real estate, much cheaper than our overpriced cities, will suddenly get accessible (and perhaps, finally, trading markets abroad!).

But everyone’s expecting this – I’m probably the last person to write about it. And in my experience, what every one expects, does not happen – or at least, it happens differently. If QE2 happens, I’m going to expect interest rates in India to hit the roof pretty soon – and by that I mean in one-two years. That’s what fast is in the macro-world.

And if QE2 happens, I will stay long. We could go much further in the markets before we turn around – the money flow is that much.

  • Anonymous says:

    >Just a thought: What if FED just talks of buying Treasuries but actually does not do. Talking is much cheaper than actual buying.

  • Px says:

    >Arnt we getting too worried?
    is it time to be contrarian?
    in any case if there is qe2 or qe3, what we have to worry is the real threat of inflation , which will come when rbi intervenes in the markets on behalf of the exporters.
    Plus there is serious food inflation in the west, ok not threatening but corn up 40% burger meat more than that there is going to be problems here, thanks to rising food prices