Time has come for international financial markets to price in the most likely follow-up of America’s QE2, as bets that the second round stimulus would trigger employment and growth have finally failed. With the program expiring, and the US registering the slowest pace of payroll growth in eight months during May, talk of exist strategies has given way to expectations of yet more monetary easing, especially in Asia, where currencies have already started appreciating.
Indonesia, looking to contain six per cent inflation, embodies the Asian dilemma. A text book interest rate hike would amount to begging for increased hot money inflows as investors rush for higher returns. Lowering rates, on the other hand, will fend off speculative assaults, but at the cost of higher inflation that is already complicating the growth trajectory.
US-Asia linkages are being tested in unprecedented times as the Fed, European Central Bank (ECB) and Bank of Japan (BoJ) continue to hold rates at and around their lowest levels. And even if more stimulus is not immediately forthcoming in America, markets see little signs of meaningful rate reversal anytime soon, contrary to what investors were initially made to believe. This is where things get complicated and strategies become self-defeating.
Much of the economic north is barely growing, which means that liquidity unleashed by further US easing will not benefit its own economy (where it is needed), rather head for emerging Asian economies with higher growth and interest rates (which would rather do without it). Already, the prospect is reviving memories of the ’97 trauma, the last time too much hot money overwhelmed Asia’s tiger economies. Having steered considerably well through the recession, they are developing a feeling that their strengthened financial systems are about to be subjected to the very scare that prompted their overhaul.
It has also not helped in this instance that markets tend to react to sentiment, a fact authorities are well aware of. By excessively playing up the stimulus program and initiating debate on withdrawing the monetary steroid, the US gambled on soothing financial markets and floating expectations of growth recovery.
But after last month’s dismal data, the market must preempt a wrongfooted Fed’s next move. Amid anemic growth, unemployment and fresh double dip fears, it seems accommodating the argument that the US would rather flush Asia with liquidity than sit on a wasted multi-trillion-dollar investment. Even though it would simply amount to repeating the exercise, with similar results, the Fed won’t be able to justify simple inaction.
These developments, on top of contagion fears in Europe and tsunami hangover in Japan, would amuse few financial managers in Asia as they brace for the inevitable influx of cheap money. Ironically, they will not bring much joy to the Bernanke Fed either. Congress is deadlocked and Republicans will avoid convergence on any fiscal package that the Democrats might leverage for face-saving. Therefore, Bernanke himself must pump more liquidity into the system, immediately raising concern about debasing the dollar and compromising its reserve currency status, with good reason. Yet, Bernanke has little choice.
This response is typical of America’s handling of the recession. First, it bailed out institutions whose irrational exuberance triggered the downturn. Then it did more of the same. Now, it is posturing towards yet more stimulus that is not only unlikely to jump start its economy, but can harm others that have handled the crisis much better.
Asian policy makers must be mindful of the false sense of security massive capital inflows tend to bring. The growth boost is in reality a prelude to bubbles that burst with severe structural consequences, something we experienced to a much smaller degree in Pakistan when the Musharraf-Aziz government boasted attracting unprecedented inflows.
Asia’s growth position is precarious. It has handled the recession well, but money the west prints for itself will find its way to Asia soon, and if inflation deepens, it will derail much of the hard work. And as the Sing dollar, Indonesian rupiah and Malaysian ringit rise, indicating trader anticipation of QE3, Asia must fine tune controls on capital influx as the next stage of the recession unfolds.
The writer is Business Editor, Pakistan Today