China and Emerging Markets – A tale of QE
This week I sat down with Erin Ade on RT’s Boom Bust to discuss what is happening in China and emerging markets and how it may affect U.S. investors as well as our domestic economy.
When the Federal Reserve began its Quantitative Easing Programs, many feared that it woul16d lead to high levels of inflation. Today, after three rounds of quantitative easing, we have very little evidence of domestic inflation and with the dollar gaining strength against most all other currencies in the world, we are actually facing some deflationary forces.
First, what is Quantitative Easing and why do people say it is all about “printing money?”
Quantitative Easing refers to the process shown below wherein (1) the Treasury Department sells Treasuries to Banks in return for cash to fund the annual deficit. This money is then spent by the federal government. Banks then turn around and sell the Treasuries to the Federal Reserve in return for cash. This cash is typically in the form of a “ credit” in their reserve account, but for all practical purposes it can be thought of as cash since these reserves can then be used to loan money to businesses and individuals, who then effectively have cash in hand.
So just how much of this did the Fed do? The chart below from the Federal Reserves shows that it bought about $4.5 trillion dollars worth of Treasuries and mortgage-backed securities during the three rounds of quantitative easing. To put that in context, that is over 25% of US GDP during that time. With all that new money coming out into the economy, inflation was a very real concern, yet it didn’t happen.
So what did happen to all that “money printing?” A lot of it went into emerging markets.
A recent working paper published by the Bank for International Settlements titled “Global dollar credit and carry trades” found that one of the unintended consequences of the Federal Reserve’s quantitative easing program, was the significant increase in issuance of dollar denominated corporate bonds by emerging market companies where the proceeds primarily fed into existing cash balances, a form of corporate dollar carry trade. The paper cites a 2015 study that estimates that the outstanding USD-denominated debt of non-bank entities located outside the U.S was around $9.2 trillion at the end of September 2015, an over 50% increase from the beginning of 2010.
In an earlier post I pointed out just how much the USD has appreciated relative to most every other currency since the end of Quantitative Easing, making this carry trade increasingly untenable. We’ve seen more and more slowing across the globe, with commodity-heavy countries like Australia, New Zealand and Canada, (who just reported that it is now in a recession after two quarters of negative GDP growth) engaging in pretty aggressive easing cycles, that will only further weaken their currencies relative to the dollar. What is even more concerning is that a rather large percentage of these firms are in mining, oil and gas sectors and we all know what has happened to prices for those commodities! This means we have companies whose domestic currency is sliding further and further against the USD in sectors that have been utterly slammed, with outstanding USD denominated bonds, making those bonds more and more expensive every day – pushing an unwinding of this USD carry trade. I suspect traders on Wall Street aren’t the only ones stocking up on Mylanta these days.
Our discussion begins at the 20 minute mark in the video below.
https://youtu.be/867G1p-Pfzg?t=18m17s
