How to Survive in the Changing Global Financial System

Last week, the Federal Reserve announced the second round of its quantitative easing policies (QE2), and will provide $600 billion by the second quarter of next year to purchase mid- and long-term debt securities. On the one hand, the world criticizes America for its act of printing money as pushing its failures to other countries while making no guarantee to recover its economy. On the other hand, as the new capital flows in, the stock market bustles with new investment opportunities, as in the case of high oil prices before the last financial crisis. It is apparent the market is slowly self-adjusting. Taiwan needs to find a way to adapt under the changing global financial system and not be swayed by the circumstances.

Quantitative easing isn’t a newly invented monetary policy and was first known to be adopted by Japan. But the current quantitative easing of the U.S. dollar has a real impact on the world economy. The U.S. currency, known for its role as a reserve currency used in international transactions and capital preservation, will have side effects (e.g. inflation, asset bubbles) on the world economy, affecting the individual monetary policies of other countries. In particular, the impact will be strongly felt in the fast-growing Asian developing countries, whose interest rates, industrial prospects and capital returns are expected to surpass those in the United States. The freshly minted U.S. dollars are very likely to find a haven there, further creating pressure and appreciating the currencies in these countries. Appreciation hurts the export-oriented Asian developing countries and creates tension in U.S. and non-U.S. trading relations.

However, the Fed cannot be fully blamed for stirring the anger among the world’s countries. Controlling the world’s largest economy, the Fed has to face its own dilemmas in regulating commodity prices and unemployment, the two responsibilities that define the Fed’s existence. But the U.S. economy was not performing well this year. Not only was there price deflation, but also unemployment showed no signs of falling below its 10-percent level. The Fed needs some actions to cover its under-performance. With a high budget deficit and close-to-zero interest rates, the Fed finds it difficult to adjust the currency prices. The alternative is to print money to create inflation and in turn stimulate the national economy. Under the Fed’s plan, as long as America recovers, the world will prosper along with it. The current uneasiness in the world economy is only a temporary pain before a bountiful harvest.

If QE2 can slowly recover the U.S. economy, it is something we should expect. But according to Japan’s experience, we should feel less confident in drawing such conclusions. Most importantly, in the past 20 years, globalization expanded the boundaries of the world’s financial systems and changed their structures. This makes it difficult to assess the effect of a monetary policy proposed in QE2, because it is unclear how much money needs to be printed to reach the Fed’s target goal, and it is difficult to control where the money flows. But looking back, wasn’t it the case that the disappointing QE1 results led to the current QE2?

Moreover, monetary policy has the characteristic of being “easy to produce and hard to collect.” Since Bernanke served as the Fed’s chairman in 2006, the Fed’s credit borrowings have increased from $800 billion to $2.2 trillion and may top $3 trillion in the near future. It would be absurd to see such a huge capital retreat leaving behind a clean trail. Such capital would surely create suspense in the financial market movements from now on.

Although the cost outweighs the benefit in the new wave of quantitative easing, it is important to note that, in the short run, unless the American economy makes a surprising recovery, the trigger for QE policy could activate at any time. Hoping that America retracts its policy, countries will have to wait in futility. Countries — in addition to continuing harsh criticism of the U.S. policy — should also consider three levels of strategies. First, expect international collaboration to create an effective constraint. In the G-20 summit, talks have begun on policies to improve the international monetary system to prevent a “no winner” situation. At the same time, to lessen the impact from changes in the U.S. dollar, the role of developing countries has been reflected. Although as of yesterday, countries continued to speak on their own at the G-20 summit in South Korea, the overall policy has formed and should not be disregarded.

Second, countries should have a self-recovery policy to prevent hot money from flowing in — in particular, implementing a capital regulatory system. If Taiwan is to remain indecisive, not only will the hot money have a chance, it will flood the entire market. Finally, countries should return to their fundamentals by observing economic forecasts and trends in capital prices to implement their own macroeconomic policies. In Taiwan’s case, the economy is reasonably stable, but the inflation pressure is slowly felt, the housing bubble can be traced, and capital overflow continues. In the face of changes in the global financial system, Taiwan’s monetary policy should continue to stay alert.