Why QE3 won

2nd October 2012

No sooner had Federal Reserve Chairman Ben Bernanke announced a third round of bond buying or QE3, did Guido Mantega, Brazil's finance minister, attack the U.S. for reigniting global currency wars. "The US pursues protectionist policies. Any country that manipulates its currency is practicing protectionism. We don't do that," Mr Mantega told The Financial Times  in an interview in September. The Fed's QE3 would "only have a marginal benefit [in the US] as there is already no lack of liquidity. . . and that liquidity is not going into production," he said.

By aggressively buying bonds, Brazil and other emerging markets argue, the Fed debases the dollar's value and makes their economies less competitive.  Moreover, it puts upward pressure on food and energy commodity prices. And The Wall Street Journal's Alex Frangos says the newly printed 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.

But a Bloomberg View editorial argues, however, that the Fed's primary goal is not to manipulate the dollar but to expand domestic demand: "It hopes to do this mainly by lowering interest rates and convincing investors that rates will stay low for a good while. This should encourage consumers to spend and companies to hire and invest. If these things happen, U.S. imports will rise and exporters such as Brazil can expect to benefit…. QE3 sure isn't currency war."

Joining in on this analysis, Alex Frangos says that unlike in 2010 when the Fed launched its second round of bond buying – QE2 , many of these emerging markets were preoccupied with controlling inflation and felt threatened by Fed efforts to spur growth.  But with growth in these emerging economies now grinding to a halt, QE3 has the potential to help, not hurt.

Indeed, "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."

Yet, despite Mantega's false claims about the impact of QE3, his wider concern about currency manipulation is right, according to the Bloomberg piece. "Indeed, it is an issue over which Brazil and the U.S. should make common cause."

It says that although China is the leading offender when it comes to currency manipulation, by no means is it alone: "Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics, recently posted a list of 20 currency manipulators, ranked by foreign- exchange reserves. China tops the list, followed by Japan, Saudi Arabia, Russia, Taiwan, Korea, Hong Kong and Switzerland."

Therefore, the editorial favors adding currency oversight to the duties of the World Trade Organization or the International Monetary Fund. "This makes excellent sense because currency manipulation can add to trade-policy friction and vice versa, in a cycle of mutually assured disadvantage."

"Meanwhile, Mantega and other finance ministers need to be more careful about whom they accuse of waging currency war. The U.S. isn't among them."


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