Pimco's El-Erian: Ultra-Loose Fed Policies Make Big Splash Abroad

Wednesday, 12 Sep 2012 09:19 AM

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The Federal Reserve has slashed interest rates to near zero and has pumped trillions of dollars of liquidity into the U.S. financial system whenever and wherever possible to spur investing and encourage job creation.

Sister central banks in Europe and Japan have taken similar actions, and eventually, all that liquidity will make its way to big emerging markets like Brazil and disrupt policymaking, said Mohamed El-Erian, CEO of Pimco, manager of the world’s largest bond fund.

The Fed in particular has led the way, launching two rounds of quantitative easing (QE), under which the U.S. central bank buys bonds like Treasury holdings or mortgage-backed securities from banks with freshly printed money, a move that pushes interest rates down across the economy to spur recovery.

Editor's Note: You Deserve to Know What Obama and Bernanke Are Hiding From Americans

Side effects to such policies include a weaker dollar that comes with the surge in liquidity and rising stock and commodities prices, gold and oil especially.

Eventually, all that liquidity seeps abroad, as investors take cheap dollars to buy other currencies to invest in stocks and in other asset classes elsewhere, especially in venues offering better returns.

The result has been a series of headaches for policymakers overseas.

“The more western central banks inject liquidity into their economies, the greater the splash for other countries. The result is something that has been experienced by countries such as Brazil: significantly greater exchange rate volatility, disruptive flows of capital and higher tensions between domestic and external realities,” El-Erian wrote in Brazil’s Estado de Sao Paulo and translated by The Huffington Post.

“Brazil and other responsive emerging countries have responded by recalibrating their macroeconomic policy mix. They have aggressively cut interest rates while tightening fiscal policy; and they are looking to revamp structural reforms,” El-Erian added.

The Fed is widely expected to follow up with a third round of QE to spur a U.S. economy plagued by sluggish growth and stubbornly high unemployment rates.

The European Central Bank and the Bank of Japan have moved to loosen policy this year, while authorities in China have said action might be needed to get growth back to its once robust levels.

Meanwhile, monetary policy actions have been carried out rather unilaterally, with little coordination to speak of among major central banks up to now.

That leaves emerging markets planning to deal with another rush of liquidity.

“Have no doubt. While most countries would prefer to be just observers, they are in fact reluctant participants in one of the biggest monetary policy experiments of all time. The entire world shares an interest in the success of this unprecedented endeavor — after all Europe and the United States anchor today’s international monetary system and will do so for quite awhile,” El-Erian wrote.

“Yet in hoping for success, we are all well advised to also think of the range of contingency steps to deal with the collateral damage and the unintended consequences.”

The Federal Reserve is currently meeting to discuss monetary policy, and surveys show most economists feel further easing is likely but won’t do much to spur recovery and increase hiring, since monetary intervention by its nature carries diminishing returns.

A new CNBC survey of 58 money managers, strategists and economists finds that 90 percent feel the Fed will announce a new round of QE in the next 12 months, 77 percent of which see action coming out of the Fed’s current meeting.

However, 36 percent of the respondents think further easing will help lower the unemployment rate with 59 percent saying it won’t.

“The Fed signaled a likely September policy move in the prior minutes, and the last employment report should seal the deal around QE rather than a communication change,” wrote Mike Englund of Action Economics in response to the survey, CNBC added.

The economy added 96,000 jobs in August, well below market forecasts for 125,000 jobs or even higher.

“Nevertheless, there is likely little economic benefit from further QE action despite the defense made by Chairman [Ben] Bernanke at Jackson Hole. The Fed is simply trying to look like part of the solution rather than part of the problem.”

The minutes from the Fed’s last monetary policy meeting showed that more voting members favored jolting the economy should it fail to gain steam, while Bernanke hinted at the Fed’s annual Jackson Hole symposium recently that further intervention might be necessary.

Editor's Note: You Deserve to Know What Obama and Bernanke Are Hiding From Americans

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