November 16, 2010

Dreams Die Hard

QE2 as Self-Inflicted Wound

By PETER LEE

It doesn't seem that President Obama was prepared for the global firestorm of criticism QE2 has ignited. (QE1 was the TARP-era liquidity jolt to the financial system.)

Overseas, QE2 is not seen as a Hail Mary attempt to goose the U.S. economy by using a gush of liquidity to induce inflationary expectations.

Instead everybody sees it as a surefire method to devalue the U.S. currency by driving interest rates down and, more importantly, sending a few hundred billion dollars galloping overseas to drive up the value of other peoples' currencies and boost US exports while cutting imports.

Bear in mind that the currencies of most countries have strengthened over 10 per cent against the dollar in 2009.  Brazil, 34 per cent.  That's a lot.  And, with QE2, there will probably be more.

Paul Krugman leads the chorus of US econo-wonks defending QE2 as a) an unavoidable domestic measure and b) justified in any case by the inability of the nations of the world to sort out the "global imbalances" mess.

Not so. The United States, as issuer of the world's de facto reserve currency, has certain responsibilities. We're pretty much allowed to print as much currency as we want to cover our deficit.  In return, pretty much everybody else gets to have a trade surplus with us (not just China and OPEC; the EU, Japan, South Korea, etc.).

You could say that Treasury's real job is matching money creation to global GDP conditions, not just America's. Our position as the world's demand engine elicited the loyalty of the world's democracies, and the respectful attention of China. It's the most effective and efficient way of projecting American power, using the energy, creativity, and omnipresence of the marketplace. Also not terribly expensive if you look at the alternative: trying to project power militarily in money pits like Afghanistan and Iraq.

Per B.B. King, Call it Paying the Cost to be the Boss.

The flip side is we're not supposed to dump liquidity in the global market and put appreciative pressure on everybody's currency just because Congress can't pass a stimulus package. And, most importantly, we don't do it unilaterally. Clearly, the United States wants to get out of the "engine of the world economy" business.

It could be reasonably argued--and I think President Obama is obliquely making the case-- that our trade partners should suck it up and let our exporters make a few billion dollars of hay overseas as partial repayment for the fifty years we've put in as the world's last-resort purchaser of underwear, cars, and crappy toys.

But the Obama administration has spent the last year methodically kicking the ass of the country positioned to turn into the world's best customer--China--in every available diplomatic forum.  So Beijing is not in the mood to do Washington any favors.

And, instead of continuing to isolate and attack China for its undervalued RMB, the United States undertook a de facto devaluation that has gored everybody's ox--our allies as well as China. And, beyond devaluing our currency, the United States has conceded that it is out of the stimulus business.  We're not going to grow the pie.  We're going to fight with everybody--the EU, Japan, etc. as well as China--to get a bigger slice.

Trade War!

Now a lot of countries--Japan, Thailand, Philippines, South Korea, Brazil to name a few--are trying to limit the rise in the value of their currencies against the dollar and maintain their export competitiveness. At the G20 summit in Seoul, the other nations tried to deal with the consequence of the US devaluation and put the brakes on the currency war by issuing a statement deploring "competitive devaluations".

I've done a quick scan of the US media and I haven't found anybody yet that recognizes that the "competitive devaluation" statement was a direct repudiation of the train of events set in motion by the US monetary easing. Also, nobody seems to have picked up on the quixotic nature of the rejected US proposal: a condemnation of "undervaluation".

Everybody's trying to undervalue now.  It's not just China.  Nobody wants to sacrfice their exports in a noble quest to find out how low the dollar can go.

I sympathize with President Obama and his difficulties.

The Republican agenda seems designed to achieve a failed presidency and forestall President Obama's re-election: no economic recovery, legislative gridlock, no peace in the Middle East, and plenty of grinding, unproductive conflict with Iran and China.

But it looks like QE2 was a self-inflicted wound, born of domestic political and economic calculations that gave inadequate weight to its global impact.

I hope President Obama doesn't go into history as America's Gorbachev, the guy who took the politically devastating step of admitting that the imperial equation no longer computed.

But dreams die hard. And waking the dreamer has its cost.

Peter Lee is a business man who has spent thirty years observing, analyzing, and writing on Asian affairs. Lee can be reached at peterrlee-2000@yahoo.

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