It would seem from recent policy announcements emanating from the United States that a third round of quantitative easing (QE3) is round the corner. Indeed, given renewed global inflationary pressures, it would seem QE3 has already been unleashed. It reflects both a paucity of options to revive the US domestic economy in the short run and the inability to take the tough decisions that would enable economic revival in the medium to long term. The ramifications of this economic unilateralism are likely to reverberate globally. Commodity prices are likely to head north thanks to an injection of liquidity into a global system already awash with it. Interest rates, already close to zero in the US, will inevitably to lead to capital outflows by investors seeking to arbitrage interest rate differentials. A weak US dollar will reduce imports by making them more expensive, unless the US continues to ignore an increasing trade deficit. Measures such as quantitative easing coupled with near zero interest rates, without the accompanying structural reform, are Band-Aid solutions at best. By themselves, they have been utterly ineffective in sparking an economic recovery, as the example of Japan a decade ago and the US experience with two earlier rounds of quantitative easing vividly illustrate. Particularly in the case of the US, the key to economic recovery lies in reining in a humongous fiscal deficit.
A new round of quantitative easing will expectedly provoke worldwide anger, especially from developing countries which would have to deal with the double whammy of higher commodity prices and declining export revenues. It is likely to renew calls for an alternative reserve currency to the dollar, though there is no consensus on a viable alternative. Countries like China which have their foreign exchange reserves predominantly dollar-denominated – close to half of China’s forex reserves are US treasury bonds – will probably have to bite the bullet, if only to prevent the dollar’s value from collapsing. It is anybody’s guess as to how long this precarious situation can continue. The fractious politics currently underway in the US is principally responsible for preventing an effective response to the crisis. Even more ominous is the prospect of the can being kicked down the road, because no political party is willing to alienate its core constituency. The consequence of such myopia is that economic agony both within the US and globally will continue. The US must step up to the plate and display the leadership the world expects of it.
