Two Poor Choices: US Quantitative Easing and the European Stabilization Facility
Until mid-October the consistent trend in the currency markets had been to a weaker dollar. The reason for the dollar slippage was the revival of U.S Central Bank's monetary easing policy announced, though not directly, at the Sept. 21 FOMC meeting. This policy would flood the American and world economies with $600 billion new dollars over the next eight months, prompting U.S. inflation and exciting worldwide fears that the U.S. national government has an unstated policy of debt monetization. The dollar sold off hard beginning with that September meeting. But in the middle of October the dollar collapse halted then reversed. Fed policy is unchanged. Mr. Bernanke and the dollar have been rescued by the sovereign debt catastrophe in Europe.
A collapsing dollar was always one of the risks of the QE. It was a risk that the Fed was willing to take. But even the limited distance that the dollar had fallen up to mid-October had aroused an enormous amount of foreign government criticism of the U.S. policy. And to be fair it also garnered some loyal support from the British and Canadian governments. But the volume of complaint would have been far worse if the EMU debt problem had not intervened to reverse the decline in the dollar.
The subsequent dollar recovery, especially against the euro, coincides exactly with the re-emergence of the European debt problem. The rise in Irish, Portuguese, Greek and Spanish sovereign yields began in mid-October.
For the first six months of the year, from January until June, the dollar benefited from a widespread safe haven effect that was specifically caused by the Greek EMU/EU sovereign debt crisis.
This wave from the EU debt problem began to reverse out of dollar assets in early June after the May settlement of the Greek situation, and lasted until early August. But even when this reversal stopped the dollar continued to fall moderately in August and early September. The FOMC meeting on the 21st gave the dollar a large additional leg down.
Though the dollar has strengthened in the past month, it is not due to the potential for positive economic results from the new Fed policy.
QE2 will not succeed and is probably unnecessary. The first QE policy which began in March 2009 and encompassed $1.75 trillion dollars was almost three times as large. It did not prevent the unemployment rate from rising to 10.1% in October of that year or remaining at 9.5% or above since; it did not break the decline in housing prices, revive consumer spending, stop consumer deleveraging or inhibit disinflation. Quantitative easing cannot be successful because liquidity in the U.S. economy is not the problem. The lack of business confidence and consumer confidence is the crux.
This QE round has also had a destabilizing effect on the world economy. It undermined the US contention that China is the world’s chief currency manipulator, though China certainly does manipulate the Yuan.
Nothing short of a renewal of the financial crisis or a war could have rescued the dollar from the effects of the Fed’s QE program quite as effectively as the spreading EMU debt crisis, which is living up to the most critical fears of contagion.
Sovereign debt is a problem inherent in the structure of the EMU and the euro but the Europeans and their instructions have refused to see it as such. It will be with the currency markets until the underlying misalignment of the weak economies of the southern tier with the strong economies of the north through the euro is corrected. Angela Merkel of Germany has had the clearest vision. She is right there will be write-downs, bond holders will have to bear some of the losses. And when that happens the euro will fall hard and the dollar will soar.
The dollar and the Fed does not deserve such helpful relatives, but as the saying goes, you can choose your friends but not your family.
Joseph Trevisani is Chief Market Analyst for FX Solutions