The Unintended Consequences of Quantitative Easing on Emerging Markets

"This paper will discuss the consequences of QE outside of developed markets—where most of the QE has taken place—and its effects on emerging markets. Specifically, it will highlight the massive liquidity pouring into emerging markets, identify the primary source and reason for the excess liquidity, and provide specific examples of how QE has inadvertently disrupted emerging-market currencies, exports, inflation levels and more."

Key takeaways

• In recent years, central banks of developed markets have used quantitative easing (QE) in an attempt to stimulate their economies, increase bank lending, and encourage spending.

• To date, however, the greater availability of credit in developed markets has not been offset by demand, resulting in an abundance of excess liquidity.

• Much of this surplus capital has flowed into emerging markets, which has had adverse effects on their currency exchange rates, inflation levels, export competitiveness, and more.

Excerpts

"Japan is credited as being the first to implement modern quantitative easing. Its inaugural QE program in 2001—in response to the persistent economic slump following the Japanese stock and real estate market crashes in 1989—was the first of its kind in post-World War II financial history. But it wasn’t until the past few years that QE was iplemented with such regularity and scale. And the collective magnitude of that liquidity—exacerbated by the globalization of financial infrastructure—has been a catalyst for the turbulence in emerging markets today."

"This has led to the perception that investment flows play a destabilizing role in macroeconomic and financial systems. However, this view is untrue. Th pre-existing condition preceding all these aforementioned crises has been
excessive bank lending, which, at its simplest level, boils down to supply outstripping demand."

"Despite its best intentions, the much-awaited thrust from QE remains elusive in developed markets, primarily because the higher availability of credit has not been met by a higher level of borrowing. Instead, data from the Bank of International Settlements (BIS) shows that the growth of credit and lending to private borrowers (i.e., non government entities) is occurring in emerging markets."

...

"Yet recent evidence has corroborated that commodities and equities are beginning to move in lockstep. If this trend continues, it could detract from the diversification benefits of commodities.Also, to the extent that commodity pricing becomes detached from real supply and demand factors and becomes linked to financial factors, the closer it comes to the direct influence that monetary policy can have on financial markets. Thus, the entrance of QE onto the world stage has the power to affect core inflation in emerging markets through the financialization of commodities."

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