The U.S. QE Policy and Its Ripple Effect



SINCE the onset in 2008 of the devastating financial crisis, the U.S. has suffered soaring unemployment and a sluggish economy. To fuel the domestic economy, on December 16, 2008 the U.S. Federal Reserve lowered the overnight federal funds rate to between zero and 0.25 percent. It remains at this record low range. Moreover, to stabilize the banking system and bolster economic recovery, the Fed introduced three rounds of quantitative easing (QE). The first round debuted on November 24, 2008 when the Fed announced it would purchase US $100 billion in bonds and US $500 billion in mortgage-backed securities (MBS) issued by the Federal Home Loan Mortgage Corp., Federal National Mortgage Association and Federal Home Loan Bank, in a bid to stabilize the American banking system. Despite showing a temporary improvement, the U.S. economy did not project robust growth prospects, and late June 2010 saw a worsening of economic data. The central bank then introduced a second round of quantitative easing. Owing, however, to only a moderate pace of economic growth and elevated unemployment, the Fed announced on September 13, 2012 that it would introduce a third round of unconventional monetary policy. This time, the US central bank opted to purchase agency mortgage-backed securities (MBS) at a rate of $40 billion per month, and to put off the deadline for its ultra-low interest rate from the scheduled 2014 to mid-2015.

The U.S. economic landscape, however, shows no clear sign that this unconventional monetary policy has achieved its expected goal. When the first round of quantitative easing (QE1) ended in March 2010, the Fed had spent around US $1.725 trillion on purchasing agency MBS, US government debts and agency securities. The QE1 nonetheless lent its support to the U.S. economic recovery, which was then overshadowed by the European sovereign debt crisis originating in Greece. Consequently U.S. employment, consumer spending, housing sales and industrial output did not experience the expected robust rebound.

In spite of its somewhat disappointing results domestically, the U.S. QE policy has significantly influenced the global economy. Countries strapped by the economic crisis have in succession replicated this unconventional monetary policy in hopes of reducing their burden of debt to China, Brazil, India and Russia – all emerging economies. In the last decade, the latter countries have enjoyed rapid social and economic development, their foreign exchange reserves (FER) having significantly increased, so enhancing their ability to resist global financial risks. They have moreover become creditor nations to developed countries. For example, China has become the richest country in terms of FER, its dollar reserve in the form of U.S. national debt accounting for about 70 percent of its overall FER. The U.S. QE programs have thus undoubtedly diluted the country’s debt to creditor countries including China. In a sense, the QE policy is reshaping the global pattern of credit and debt.

Through trade, the U.S. QE policy has also put imported inflationary pressure on emerging countries. As the dollar is the world major pricing currency for resources and bulk commodities, its depreciation directly drives up their prices. The demands of emerging countries for raw materials, bulk commodities and energy mainly rely on imports. To ensure their economic growth, therefore, these countries have to pay more in dollars for such imports. As prices of bulk commodities rise, so too do those of capital goods, which in turn hike commodity prices on their domestic markets, forcing emerging economies to curb inflation and adopt tight monetary policies – measures that will inevitably slow their economic growth.

The new round of quantitative easing will also pump hot money into China’s Hong Kong Special Administrative Region (HKSAR). As the HK dollar is pegged to the US dollar, this will heighten the region’s inflation risk. In the month after the QE3, an influx of hot money poured into the HKSAR, forcing appreciation of the Renminbi and HK dollar and so precipitating a spike in local housing prices. On October 20, the Hong Kong Monetary Authority bought US $603 million within a trading range of HK $7.75 to a US dollar in efforts to maintain the stability of its currency.

As the effect of the U.S. QE policy intended to stimulate economy weakens, there is little likelihood China will make any appreciable gain from the U.S.’s economic recovery. The QE1 and QE2 aimed to boost the U.S. recovery by lowering the long-term government debt yield rate, promoting market liquidity, decreasing the discount rate, invigorating the stock market, and stimulating consumption. The two rounds of QE played their roles through these channels, but they are now becoming congested because of the limited build-up effect in the early stages. The QE3 will consequently be less effective in boosting U.S. economic recovery and employment. If the QE3 does live up to its expected role, which will entail robust economic growth and a brighter employment situation, China will of course benefit from the policy, since the U.S. is one of China’s major export markets. Countries neighboring the U.S. , however, will benefit most, in particular those in the North American Free Trade Area.

Since last September, developed countries have adopted expansionary monetary policies in succession in a bid to maintain the existing global economic pattern and monetary system. The worldwide new round of QE kicked off after the 2012 annual meeting of central banks. On September 6, the Bank of England announced that it would keep benchmark interest rates at the historical low of 0.5 percent and continue with its program of asset purchases totaling 375 billion pounds sterling, financed by the issuance of central bank reserves. Meanwhile, the European Central Bank introduced the Outright Monetary Transactions (OMTs) program of purchasing the sovereign bonds of European Union member countries with no pre-set limit in secondary sovereign bond markets. On September 19, Japan’s central bank announced that it would add another 10 trillion yen to its government securities purchase program to further its QE policy. Certain emerging economies proactively took measures to offset the influence of those countries’ QE policies. On September 4, Brazil’s central bank announced that it would lower its benchmark interest rate by 0.5 percent to 12 percent. On September 17, India’s central bank announced it would hold its benchmark interest rate at 8 percent, but cut the reserve requirement ratio for banks by 0.25 percent to 4.5 percent. On September 13, Russia’s central bank opted to hike its refunding interest rate by 0.25 percent to 8.25 percent, its repurchase interest rate by 0.25 percent to 6.50 percent for the fixed term of one day, and the deposit interest rate by 0.25 percent to 4.25 percent – all in efforts to curb the outflow of risk assets.

At present, China is implementing a prudent monetary policy, but must keep a close eye on the QE policies of major economies and take measures to offset their negative effects. China should make long- and mid-term preparations to seize opportunities brought about by the U.S. economic recovery.