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Financial Markets Tensions Rise as Global Policymakers Part Ways

Politics / Global Financial System Oct 15, 2010 - 07:29 AM GMT

By: Mike_Larson


Best Financial Markets Analysis ArticleThe tension out there is so thick you can cut it with a knife. I’m talking about the tension building between central bankers and policymakers in developed nations and their counterparts in so-called emerging market countries.

On the one hand, you have policymakers here, in Japan, and in England promising to print money until the cows come home. Their aim is to boost their faltering domestic economies and combat deflation.

But the money isn’t staying at home. It’s flowing outward to emerging markets all over the world. That’s helping wildly inflate assets, inflation, and currencies there, risking the emergence of new bubbles to replace the old ones. So foreign central bankers and policymakers are fighting mad, and starting to push back at the developed world.

How will this epic battle end? What are the causes and potential fallout of this global policy war? Let me weigh in now…

QE2 Coming, Consequences be Darned!

Federal Reserve Chairman Ben Bernanke and his fellow board members have all but promised to throw more free money from helicopters. That’s the only conclusion you can draw from the minutes of the Fed’s September 21 meeting.

Those minutes indicated the Fed would “consider it appropriate to take action soon” in order to generate inflation. I expect to hear about several hundred billions of dollars in fresh funny money printing at the conclusion of the Fed’s November 2-3 policy meeting. The Bank of Japan has already announced similar actions, and the Bank of England probably isn’t far behind.

The problem?

New money is leaving the U.S. as fast as it's printed.
New money is leaving the U.S. as fast as it’s printed.

All that free money isn’t doing a hill of beans good for the domestic economies those central banks are targeting! Initial jobless claims just jumped 13,000 to 462,000, while the trade deficit surged 8.8 percent to $46.3 billion in August.

This proves that free money and a weaker currency aren’t boosting jobs or improving the balance of trade. But they did manage to “accomplish” something: Drive inflation higher! Producer prices rose another 0.4 percent in September after a 0.4 percent rise in August.

Instead of helping the “real” economy, the cash is flooding OUT of the low-rate, low-return advanced economies and flooding IN to higher-rate, higher-return developed markets and hard assets.

Harvard University professor Niall Ferguson told CNBC a few days ago that:

“All that liquidity ends up not where it is supposed to be, which is magically creating jobs for American workers in Michigan. It doesn’t do that at all. It ends up pumping up commodity prices on the other side of the world, with lots of unforeseen consequences.”

The New York Times, for its part, warned that:

“Economic weakness and low interest rates in advanced economies are prompting an extraordinary flow of investment to healthier emerging markets, undermining their exports as their currencies appreciate and creating the risk of destabilizing asset bubbles.”

Richard Barley, writing in The Wall Street Journal, added:

“The prospect of more QE — when investors are already gobbling up 100-year bonds, record levels of junk debt and subordinated hybrid corporate issues — could create new distortions, adding to both the political and financial pressures in global markets … The snag is that policy makers in developed countries can undertake QE, but can’t control the end result.”

Foreign Officials Fighting Back and Losing … So Far

For a while, central bankers and policymakers in several foreign countries were willing to sit by and let things play out. But their frustration is growing by the day. They’re now trying all kinds of things to stem inflows into their bonds, stocks, and currencies …

  • Brazil recently doubled a “financial operations tax” on foreign inflows into its bond market to 4 percent from 2 percent.
  • Thailand just axed a 15 percent income tax exemption for foreign owners of Thai bonds, effectively making it more expensive to own Thai securities.
  • And South Korea just announced it will more closely “inspect” foreign currency activities at leading banks, a back-handed way of trying to stem gains in the value of its currency, the won.
On October 5, Brazil doubled the tax on fixed-income inflows to slow the real's appreciation.
On October 5, Brazil doubled the tax on fixed-income inflows to slow the real’s appreciation.

All throughout this period, Asian central banks have also repeatedly intervened in the market to try to prop up the greenback against their currencies. A firm called IFR Markets estimates that in late September and early October, regional central banks sold their own currencies and bought almost $29 billion worth of dollars.

But so far it hasn’t helped. The Korean won, Thai baht, Malaysian ringgit, and other regional currencies have risen anyway! So too have their bond, stock, and real estate prices — to say nothing of broad-based inflation.

This is an inherently unstable state of affairs. You can’t continue to have the Fed print like mad, and foreign and hard assets skyrocket in value forever, without destabilizing the entire global financial system. Something has to give, and any number of dire consequences — a dollar collapse, a surge in inflation and interest rates, a massive collapse in overvalued asset prices — could result.

My take?

Profit from the moves we’re seeing in the capital markets if you’re nimble and an active trader. But keep an eye on the exits. Take profits along the way. And be wary for out-of-the-blue reversals, because global economic tensions are building fast.

Until next time,


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