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Massive cash injection into US economy may inhibit world recovery
March 26, 2009, Thursday
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THE United States has announced another massive cash injection into its economy in a bid to overcome the recession triggered by the crisis.
This is a short-sighted move that may not only fail to save the US economy in the long term, but even inhibit the recovery of the world's economy.
The US Federal Reserve announced on Mar 18 that it would pump another US$1.15 trillion into the ailing US economy by buying US$300 billion of long-term government bonds and by expanding its purchases of mortgage-related securities by another US$850 billion.
Given the prevailing liquidity panic in the United States, the US government's effort to inject liquidity into the economy by all means is understandable.
However, this effort is likely to be in vain as long as predictions for the US market remain pessimistic.
In this situation, banks and financial institutions in the US tend to take advantage of the liquidity injected by the government to raise their lending interest or the rates of return for corporate loans to make up for possible future losses from insufficient liquidity.
This will give rise to a huge liquidity trap that will render the government's cash injections - however huge - useless.
And this is not the only problem the US government's excessive cash injections would bring.
They will also result in the weakening of US dollars and the lowering of the rates of return of US government bonds within the short term.
US dollars will continue to weaken in the medium- and long-term due to the US' huge financial deficit and trade deficit.
As to the steadiness of the rates of return of US government bonds in the long term, it depends on the effectiveness of the government's market-revival policies and the speed at which the world's economy recovers.
In short, the value of dollar assets will be seriously affected for a fairly long time.
In addition, the weakening of dollars will inevitably add to the pressure on the appreciation of local currencies in emerging markets.
On the one hand, capital in the US market is likely to flow into emerging markets where there are higher returns on investment, causing excessive liquidity and an unreasonably high demand for local currency.
The challenge would be especially evident in countries like China, which are undergoing marketization of exchange rate and capital management.
This requires countries to find a way to make good use of liquidity from overseas while maintaining healthy development of the financial system.
Inflation
On the other hand, the pressure on the appreciation of local currencies may bring shocks to export-oriented enterprises and the industrial restructuring of emerging markets.
As China's economic growth mode has long been highly dependent on exports, adjustments within a short time can be difficult.
China is likely to face greater pressure on the appreciation of its local currency.
Thus, this poses an urgent problem for China to ensure the soft landing of its industrial restructuring and the profits of export-oriented departments.
Last but not least, the US' expansionary monetary policy adds to the risk of stagflation - an economic situation in which inflation and economic stagnation occur simultaneously and remain unchecked for a period of time.
Countries all over the world will have to loosen their monetary policies - by further reducing interest rates, for example - to avoid the possible negative effects that the US' monetary policies may bring them.
Such senseless competition of expansionary monetary policies may quicken the pace of inflation and delay the recovery of the world's economy.
(The author is professor of finance and executive vice dean of the School of Economics at Fudan University.)
This is a short-sighted move that may not only fail to save the US economy in the long term, but even inhibit the recovery of the world's economy.
The US Federal Reserve announced on Mar 18 that it would pump another US$1.15 trillion into the ailing US economy by buying US$300 billion of long-term government bonds and by expanding its purchases of mortgage-related securities by another US$850 billion.
Given the prevailing liquidity panic in the United States, the US government's effort to inject liquidity into the economy by all means is understandable.
However, this effort is likely to be in vain as long as predictions for the US market remain pessimistic.
In this situation, banks and financial institutions in the US tend to take advantage of the liquidity injected by the government to raise their lending interest or the rates of return for corporate loans to make up for possible future losses from insufficient liquidity.
This will give rise to a huge liquidity trap that will render the government's cash injections - however huge - useless.
And this is not the only problem the US government's excessive cash injections would bring.
They will also result in the weakening of US dollars and the lowering of the rates of return of US government bonds within the short term.
US dollars will continue to weaken in the medium- and long-term due to the US' huge financial deficit and trade deficit.
As to the steadiness of the rates of return of US government bonds in the long term, it depends on the effectiveness of the government's market-revival policies and the speed at which the world's economy recovers.
In short, the value of dollar assets will be seriously affected for a fairly long time.
In addition, the weakening of dollars will inevitably add to the pressure on the appreciation of local currencies in emerging markets.
On the one hand, capital in the US market is likely to flow into emerging markets where there are higher returns on investment, causing excessive liquidity and an unreasonably high demand for local currency.
The challenge would be especially evident in countries like China, which are undergoing marketization of exchange rate and capital management.
This requires countries to find a way to make good use of liquidity from overseas while maintaining healthy development of the financial system.
Inflation
On the other hand, the pressure on the appreciation of local currencies may bring shocks to export-oriented enterprises and the industrial restructuring of emerging markets.
As China's economic growth mode has long been highly dependent on exports, adjustments within a short time can be difficult.
China is likely to face greater pressure on the appreciation of its local currency.
Thus, this poses an urgent problem for China to ensure the soft landing of its industrial restructuring and the profits of export-oriented departments.
Last but not least, the US' expansionary monetary policy adds to the risk of stagflation - an economic situation in which inflation and economic stagnation occur simultaneously and remain unchecked for a period of time.
Countries all over the world will have to loosen their monetary policies - by further reducing interest rates, for example - to avoid the possible negative effects that the US' monetary policies may bring them.
Such senseless competition of expansionary monetary policies may quicken the pace of inflation and delay the recovery of the world's economy.
(The author is professor of finance and executive vice dean of the School of Economics at Fudan University.)
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