Effects of Quantitative Easing 2 on Asia

With quantitative easing, or QE, dominating headlines, it may be worth examining exactly what this policy entails, as well as its implications on Asia. Simply put, quantitative easing is a monetary policy whereby central banks create new money to buy securities from the open market. Because we live in a world of electronic money, the U.S. Federal Reserve does not have to literally print money. However, the effect of quantitative easing is the same—it increases the money supply.

When the supply of anything increases, the price typically falls. Therefore, the U.S. dollar has weakened. In addition, by increasing the overall monetary base, quantitative easing is estimated to lower U.S. Treasury yields by about 50 basis points (0.50%), effectively lowering the cost to borrow in U.S. dollars—U.S. Treasuries serve as the benchmark rates from which all entities borrow. The rate at which one borrows is the same rate at which a lender lends. Now that the rate of return for the lender has fallen and is expected to stay low because the market is expecting additional rounds of QE, investors are seeking yield in other markets. But where? Yields are also low in the other developed markets such as Europe and Japan because they too are undertaking quantitative easing.

Emerging markets—especially those in Asia with stronger fundamentals and lower debt-to-GDP ratios than those of developed markets—are attracting those seeking a higher rate of return on capital. However, this capital is coming at a time when most Asian countries are stepping on the brakes to cool their economies. As such, Asia’s central banks are looking to all monetary policy tools at their disposal to achieve a more sustainable pace for economic growth. Raising short-term interest rates is one way, but it has had the perverse effect of making the market even more attractive to U.S. and European investors seeking higher yields. Another policy tool is to increase bank reserve requirements, which is already being adopted as banks are beefing up capital to meet so-called Basel III rules—the third in a set of banking rules agreed upon by central bankers and regulators from around the world at meetings in Basel, Switzerland. In addition to the use of interest rates and reserve requirements, many central banks are resorting to capital controls.

We do not believe this means that Asian governments are turning their backs on greater liberalization. International markets have typically seen capital controls as distortionary. This time, however, even the International Monetary Fund is endorsing the use of capital controls on a temporary basis under these exceptional circumstances. Indeed, the spirit of the measures implemented so far this year appears to be short-term and tactical rather than long-term and structural. Thailand removed a 15% tax exemption for foreigners on income from domestic bonds. South Korea set a limit on the level of foreign exchange derivatives and a limit on the amount of foreign currency debt that local banks can borrow. Indonesia introduced a one-month minimum holding period on their treasury bills. While the intention of the U.S. is to step on the gas pedal to stimulate the domestic economy, the effect of its quantitative easing has been to turbo-charge the emerging markets, especially the markets of Asia. There is some concern that short-term portfolio flows or “hot money” could cause sharp price volatility, and we will continue to monitor these effects and their implications on Asia.

-This article came from Matthews International Capital Management, LLC

Comments

  1. All commodity prices(oil, food etc…) would go up since US is debasing the dollar, intentionally, to be competitive in the market. It is expected since US is the world currency reserve, when you dilute this particular currency, chances are that prices of all goods are going to increase. Obama mentioned this on the G20 accusing China of intentionally keeping its currency low. Reason being is because unemployment in the US is really high and that is the strategy to attract investors. It will take time for the prices to go up since the money hasn’t circulated yet in the system but it will eventually go up.
    Another factor to consider is because other countries are also busy printing money/pushing zeros. I don’t see the market as supply and demand anymore but more of inflation
    Another way to look at it is wealth redistribution and whoever gets the fresh money gets to use the full purchasing value of the dollar until it circulates. It doesn’t matter whether its a bond, securities or so, as long as it goes out in the market and cause inflation. Hate to see that most people just see numbers and not the lives of others.
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