Will the Fed Have to Save Emerging Markets with QE4?
The risk-off tide is rising, and sand castles of QE will only hold the tide back for a brief period of apparent calm.
A funny thing happened on the way to permanently expanding global markets: unintended consequences. Borrowing cheap, abundant U.S. dollars seemed like a good idea when the dollar was declining, and few voiced any concern when $9 trillion was borrowed in USD-denominated debt around the world in the years since 2009.
Few saw the possibility of the USD rising, or that if it did appreciate against other currencies, that the blowback would destabilize the global economy.
It turns out a strengthening USD has triggered capital flight as other currencies devalue. Anyone propping up their currency to stem the flood tide faces another unintended consequence–a faltering export sector: China: Doomed If You Do, Doomed If You Don’t (September 1, 2015).
Meanwhile, the Imperial economy is suffering its own spate of unintended consequences, notably rising yields, a.k.a. quantitative tightening. As emerging markets and nations attempting to defend their currency pegs to the USD sell U.S. Treasury bonds (which have been held as foreign exchange reserves), the yields on the Treasuries rise as a matter of supply and demand.
As supply increases, sellers must offer higher yields to entice buyers to soak up the inventory.
This increase in yields reverses the primary effect of quantitative easing, i.e. declining yields/interest rates in the U.S.
This dynamic undermines both the emerging markets and the U.S. Emerging markets are not really restored to growth by selling Treasuries; the strong dollar continues to crush their currencies and dampen growth, as assets must be sold to pay back debt borrowed in USD.
Rising rates threaten the feeble U.S. “recovery” as well.
So what’s the solution to this inconvenient dynamic? QE4, of course. Why would the Federal Reserve launch QE4, if not to push rates down in the U.S.?
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