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  November 11, 2010

Who Pays the Bill for the Fed's QE2?

Kevin Gallagher: Quantitative easing forces crippling cost on developing countries
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Kevin P. Gallagher is Associate Professor of International Relations at Boston University and a Faculty Fellow at the Pardee Center. He also serves as Senior Researcher at the Global Development and Environment Institute at Tufts University. This policy brief is an update and expansion of his forthcoming book with Roberto Porzecanski, "The Dragon in the Room: China and the Future of Latin American Industrialization".


Who Pays the Bill for the Fed's QE2?PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I'm Paul Jay, coming to you today from Tufts University in Boston. On November 11 and 12, the G-20 countries will be meeting in South Korea, supposedly to stop a currency war. And Ben Bernanke made his contribution to either stopping, or some people thinking starting a currency war. As you must've heard by now, QE2—not the boat, and not the Titanic, though maybe it will come to be known as that. At any rate, Quantitative Easing 2: put more money into the system, supposedly to be a stimulus. Well, what effect will this have in terms of the currency war and on other countries? Now joining us to discuss all of this is Kevin Gallagher. He's an associate professor of international relations at Boston University and senior researcher at the Global Development and Environment Institute, Tufts University. Thanks for joining us.


JAY: So you recently wrote a piece in the The Guardian. The title is "Who pays the bill for the Fed's QE2? By depressing US interest rates, quantitative easing forces developing countries to defend their currencies at crippling cost". So what do you mean by that?

GALLAGHER: One of the unintended effects of QE2 is that there are going to be massive capital flows from The United States to emerging markets or developing countries. Why? Because with the interest rate low, banks and investors can borrow money in the United States and then park it places where there's going to be a higher interest rate. This is called the carry trade, what nerds like me refer to it as. So you're pulling money out of the United States at a low interest rate, 2, 3, 4 percent, parking it somewhere like Brazil, 10.53 percent. That's an amazing, quick markup. Can't get that in the US economy anywhere.

JAY: This essentially is the Fed is loaning money to the big banks at practically zero, or big corporations can also get hold of money very cheaply and play this spread as well.

GALLAGHER: Yeah, anyone who wants to be involved in global investing, in the carry trade. It's one of the options that big-money investors look at when they're looking around for different options to invest in, and this is a fairly lucrative one. It's been very accentuated since 2008 because interest rates are already relatively low, but interest rates are relatively higher in developing countries, so there's been massive inflows of capital to the developing world. It has two effects. One, it raises their currencies, so their exports are more expensive. Brazil's currency's increased by 37 percent since 2008. Their stuff's more expensive out there in the world. So as we are trying to stimulate our economy, they can't get many markets around the world because their stuff's too expensive. That's one thing. The other thing that's perhaps even more concerning is the fact that this is speculative capital that's going to move in and out of their country and could cause asset bubbles in other parts of their economy. And just as quick as it comes in, if there's a change the interest rate in the United States or a little scare in a country, it can pull right out and destabilize their financial system.

JAY: So just to get it clear again, the Fed buys Treasury bills, T-bills, from big banks, or loans money very cheaply to corporate clients, but that goes through the big banks. You get—the cash goes to zero to the big banks, who make some of their own investments overseas. Or if you're a AAA corporate lender, you borrow at 2, 3 percent from the big banks, and now you take the cash to these emerging markets and it has the consequences you were talking about. So, first of all, how is this any stimulus for the American economy, which is supposedly the objective of this whole plan?

GALLAGHER: Well, we have to realize we're in a world of financial globalization now. So if you've got an open financial system, investors can take money from one country and put in another country if they see that they can get returns. So it's perfectly legal. It's unintended. And one of the—.

JAY: Or is it unintended? Is the objective of this plan to force inflation in these other countries, raise the prices of their goods, and that way make American products more purchasable here and more exportable? I mean, is this in fact just about a currency war?

GALLAGHER: I'm not sure it's just about a currency war, but it's clearly going to be an effect, and developing countries around the world are already lining up at the Fed with placards, saying, you shouldn't have done this and you're going to pay for it at the G-20 later on this week.

JAY: What does Bernanke say in response to the critique?

GALLAGHER: Bernanke said that the US is trying to get its own ship in order, and you should try to get your own ship in order. What they're going to do to get their own ship in order is put in place capital controls. These are instruments to try to keep these short-term hot money out of their country. They'll also accumulate more T-bills or accumulate more reserves to be able to make sure that their currencies are more stable.

JAY: Now, I was reading in your article that the recommendation to Colombia—I'm not sure if it came from the World Bank or not—actually saying they should have controls over this influx of capital, but Colombia doesn't want to.

GALLAGHER: Yeah, there's been a sea change in thinking about capital controls over the past 18 to 20 months. John Maynard Keynes, when he originally put together the international financial architecture, used to say that capital controls were a core part of the global financial system. Well, with neoliberal reforms and the rise of the IMF and the World Bank in the 1980s, these things became an evil specter. But, interestingly, they've come back, and they've come back in full force. There's been a number of studies by people like myself, by the IMF, by the Asian Development Bank, saying that capital controls have worked, and as a matter of fact, those countries that use capital controls were among the least worse off with this current crisis. So, yes, in Colombia, the IMF was there last week and said, one of the things you might want to consider, because you're getting so much capital into your country, is using capital controls. And Colombia said, I thought we weren't allowed to use those things. And they said, yes, they're now sanctioned. And Colombia said, well, if there's not a stigma, we'll reconsider.

JAY: Give us some specific examples how this is what you say a "crippling cost" for some of the emerging economies. Give us an example of what that is.

GALLAGHER: Well, there's two things, right? One of the things is reserve accumulation. That's where the biggest cost is. So if I need to stabilize my currency, if there's all this hot money coming into my country, dollars coming into my country, alright, that is going to raise the level of my currency. And so what I need to do is buy those dollars, get them off the street. And I do that by taking my own currency and purchasing those dollars so there's a lot of my currency out on the street. The more of it [there] is, the cheaper that it is, it'll keep down the currency. Well, those dollars, by purpose, have a low interest rate, and so the returns for that investment that a country's going to make are relatively low. And emerging markets, developing countries are growing faster than the US, so they can be putting the money into their own country. And there's been a number of studies that have shown that the economic costs are significant. A Harvard economist did a study that showed that the economic costs of purchasing reserves is about 1 percent of your GDP. So it's a 1 percent GDP loss for many countries.

JAY: These US dollars are coming in. They're flooding into my market. Let's say I'm an emerging economy. So they're doing what? They are lending it to people, they are buying assets, they're buying real estate. What are they doing with this money?

GALLAGHER: Well, they can park it in a bank, because it's going to have a higher interest rate. They can move bonds from one country to another. It really depends.

JAY: So right now, if you went to a bank, for example in Brazil, you're saying you can get 9 to 10 percent?

GALLAGHER: It's over 10—10.57.

JAY: It's over 10, by just putting it into a bank

GALLAGHER: Just by putting it into a bank.

JAY: So now that money's in the bank, a Brazilian bank. It's sitting on the money. It's paying 9, 10 percent. It's loaning it out at—.

GALLAGHER: Honestly, I can't tell you exactly what the rate is that they're doing.

JAY: But it's got to be more than that. But there's also got to be a market for it.

GALLAGHER: Sure, there's a real market [inaudible]

JAY: Or they wouldn't be paying 10. So the economies are getting so hot, people are willing to pay that kind of money.

GALLAGHER: Exactly. And one of the—these economies are growing so fast. Brazil's going to grow at over 6 percent this year. The emerging markets are growing 6, 7 percent. And so there's all sorts of folks that will buy these things at a higher premium.

JAY: Okay. Just explain the mechanism, why that inflates the value of the Brazilian currency. Now, the dollars hit the Brazilian banks. How does that get to that? How does that equal—?

GALLAGHER: Alright. So the influx of massive capital into developing countries, say in Brazil, raises the value of the currency because there's more demand for the currency.

JAY: Because for these dollars to do anything in Brazil, they have to be transferred into Brazilian currency.

GALLAGHER: They have to purchase reals.

JAY: So they're buying Brazilian, which ups the rate 'cause there's now a big demand for Brazilian currency, which also affects the cost of their exports.

GALLAGHER: Absolutely.

JAY: Okay. So explain how buying reserves opposes that if you're the Brazilian government.

GALLAGHER: Sure. So if you've got an influx of money coming into your economy, there's all these dollars in your economy, right? So you need to get those off the street. And so what you do is use your own currency, you purchase dollars, and there's more of your own currency on the road. And therefore, if there's more of it, it's less scarce and it's going to stabilize your currency, right?

JAY: And you deflate your currency.

GALLAGHER: You deflate your own currency.

JAY: So, in other words, it's a countermeasure. So if one of the objectives of QE2 was to raise the value of other currencies in order to induce people to buy more American products, this counteracts that. So you wind up in a currency war where these economies just wind up at the same net result, except the banks make a ton of money on the way.

GALLAGHER: Sure. The Brazilian finance minister has already said we're in the middle of a currency war and that the QE2 is only going to accentuate this. What's ironic is we're going into the G-20, and this is supposed to be the conversation where the US was the country that said, there are a number of things that other countries want to deal with at the G-20 meeting to get out of this crisis, but we really want to focus on currencies, because the US is concerned about China. Then we make this move a week before the meeting where we're the ones who devalue our currency. It doesn't put us on great standing going into these meetings.

JAY: Now, the Chinese are pegged to the US dollar, Chinese currency. So does it actually affect them, this QE2?

GALLAGHER: No. They're pegged, so they purchase more dollars as our currency deflates, which increases the value of their reserves, and their reserves are almost $3 trillion already. The accumulation of all these reserves is one of the core reasons why we have this financial crisis, right, that these Asian countries, for the most part China, have been accumulating so many reserves. This has accentuated what we're calling the global imbalances. So in order to save your country or your currency from this effort, we actually have to—many developing countries are accentuating some of the root causes of the crisis.

JAY: Thanks for joining us.

GALLAGHER: Thanks for having me.

JAY: And thank you for joining us on The Real News Network.

End of Transcript

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