Five years after the financial crisis broke out on Dec 19, the US Federal Reserve began to end its quantitative easing, lowering its monthly bond purchase scale from $85 billion to $75 billion, and ushering the global currency financial environment into a new currency financial period.
Since 2010, the FED’s QE has achieved remarkable effects in de-leveraging the private sector and financial departments in the United States. The rise of the stock market and the recovery of the real estate sector have also improved families’ balance sheets quickly. The rises of wealth effects and property saving stoke sustainable recovery of consumption.
The three rounds of QE policies have also improved the growth quality and sustainability of the US economy as well as the driving force for economic growth. Economic output has recovered to its pre-crisis level. The rise of manufacturing production efficiency and the improvement of the trade balance have put the US economy on a sustainable recovery track. In this sense, the QE has basically fulfilled its historical mission and the recovery of monetary policy is imperative.
The withdrawal of QE will change the global currency financial environment and the direction of money flows. We can compare the global fund structure into such a format with the US as the core, the emerging economies as the surface layer, and Japan and the Europe as the middle layer.
In the past, the core consumed a lot, the surface layer produced a lot and the middle layer loaned a lot. In the future, the scenario will see big changes. The US economy is going to be driven by “entity reconstruction” more than consumption. The global fund is flowing to the US. Especially, the aging of Chinese society and Chinese government strategies of boosting domestic demands will inhibit the growth of global savings. The time when China provides the US with cheap financing could come to an end.
The FED QE will be completely ended by early 2014. It is probable that the FED will increase the interest rate for the first time in the second quarter of 2015, and increasing interest rate will become the main means of FED to adjust its monetary policies.
Then, the FED will sell its security assets after the first interest rate rise. It is estimated that the process will last for about three to five years and will be adjusted according to the changes of economic and financial environments. That is to say, the rise of the US national treasury bond’s return rate will become an unavoidable trend.
Currently, the FED’s balance sheet has hit $3.5 trillion. From the cut of $85 billion’s purchase of bond to the normalization of the balance sheet, the reversion of capital flows and the rise of interest rate will be a medium and long-term process.
Judging from historical data, the 2 percent return rate of the 10-year US national treasury bond is at a historical low. But such a low interest rate cannot be sustained. According to estimates from the Congressional Budget Office, the return rate of the 10-year national treasury bond will be above 5 percent in five years. Because global interest rates are based on the US’ interest rate as their benchmark, the real interest rate hike in the US in the future means the global low interest rate environment will end in several years, which will raise the overall interest rate level in China.
The interest rate rise will further increase the global tail risks. The global financing cost will rise and the global capital will be reallocated, which will necessarily change the risk preferences of global capital. The asset prices of the stock markets of emerging economies, precious metals, financial assets, and currencies in the rest of the world will be readjusted.
The Institute of International Finance estimated recently that from 2013 to 2014 about $1 trillion of cross-border capital will flow out of emerging markets. IIF has lowered its prediction on the capital inflow to the emerging markets in 2014 to $1.112 trillion from this year’s $1.145 trillion, the lowest since 2009.
The FED is well prepared for the liquidity plight in the future. The FED, the European Central Bank, the Bank of England, the Bank of Japan, the Bank of Canada and the Swiss National Bank signed their bilateral currency swap agreements on Oct 31, 2013 and transformed temporary agreements into long-term ones. It means that the FED will implement a currency ration system in the next several years. Under the control of overall currency liquidity, the FED will implement structurally differentiated monetary policies for different regions of the world. The cheap dollar era will see a big change after the differentiation of global currency patterns and the phasing out of the QE.
The change in the global currency financial environment and capital flows means bigger pressures for China’s economic growth, monetary policies and structural transformation. China will see more capital flow out of its “capital pool” and will feel greater pressure to raise the overall level of its interest rate. Money will become more expensive in the future for China in an environment featuring a structural stringency of domestic liquidity, rising social financing costs and the marketization of its interest rates.
China needs to review its liberalization financial policies, especially the pace of the liberalization of capital accounts. Hastily pushing ahead the financial liberalization in a fast changing global currency financial environment may bring huge risk premiums to China, a country still in a fragile stage in its market reform of financial sectors. The authority needs to balance efficiency and risks and look for an equilibrium point among financial market reform, financial stability and financial security.
Zhang Monan is a researcher at the Strategic Studies Department of the China International Economic Exchange Center.