Monday, 17 February 2014

The True Cost of Quantitative Easing

Quantitative easing has been short-term pain relief with long-term damage and some ugly side-effects

Life on drugs must be great – but the high cannot last for ever.  Such has been the case with quantitative easing.  The financial markets have been buzzing due to the money pouring out of the Federal Reserve as part of its monetary stimulus program.  The costs of shot after shot of extra cash are easy to forget when times are good.  It is only now that the Federal Reserve has decided that it is time to wean investors off their quantitative easing fix that we are seeing the true repercussions of addiction to easy money.

Costs of kicking the habit

Investors are already getting the shakes as the Federal Reserve moves to lower the dosage of its monetary policy.  Stock markets around the world wobbled in early 2014 as the Federal Reserve trimmed US$10 billion off its monthly bond purchases in December and January.  The extent to which stock markets have benefitted from the monetary stimulus is unclear but substantial.  This means that volatility is likely to continue as share prices find their appropriate level without any interference from the Federal Reserve.

Investors have reacted strongly to any attempts by the Federal Reserve to renounce its role as drug dealer for the financial markets.  The policy of quantitative easing in itself has been like a drug habit – easy to start but tough to break.  As is often the case with bad habits, it is only when trying to quit that the real costs become apparent.

It looks as if the comedown will take the form of a lethargic economic recovery that may last for years.  Uncertainty is one of the primary stumbling blocks standing in the way of economic rehabilitation.  The slow tapering of quantitative easing followed by interest rates being gradually pushed upward will be enough to keep even the experts on edge.  Thus, while the monetary stimulus has eased the pain of the global slowdown, the economy will be held back by the “ifs” and “buts” of monetary policy.

Emerging Markets Hit by Side-Effects

If the past few weeks of stock market jitters are anything to go by, it may be emerging markets that suffer the worst withdrawal symptoms.  Many developing countries had benefited from the extra cash in the global financial system coming from quantitative easing.  Low levels of domestic savings mean that such countries rely on funds from overseas and their chronic cravings for growth make poorer countries prone to overdosing.  Their vulnerable position leaves them at the mercy of the money peddlers from wealthy countries who often have the upper hand.

It is a sad twist of fate that the worst consequences of monetary policy in the US will be felt far from its shores.  One of the reasons why quantitative easing has had little effect in boosting the US economy may be due to a considerable portion of the newly printed money heading overseas.  The amount of cash flowing out of the US has been large enough to warp the economies of some developing countries.  The hit on their financial wellbeing as the money returns back to the US has also been a downer.

A silver lining is that past crises have taught emerging markets to be more resilient – this time at least the IMF will not be kicking down any doors (like the police at a narcotics bust) as might have been the case in the past.  It is also clear that emerging markets still need to do more to better manage their addiction to foreign funds.  While emerging markets have learnt some lessons from past predicaments, we can only hope that the Federal Reserve can do the same. 

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