by Peter Schiff, EuroPacific Capital:
There is a growing sense across the financial spectrum that the world is about to turn some type of economic page. Unfortunately no one in the mainstream is too sure what the last chapter was about, and fewer still have any clue as to what the next chapter will bring. There is some agreement however, that the age of ever easing monetary policy in the U.S. will be ending at the same time that the Chinese economy (that had powered the commodity and emerging market booms) will be finally running out of gas. While I believe this theory gets both scenarios wrong (the Fed will not be tightening and China will not be falling off the economic map), there is a growing concern that the new chapter will introduce a new character into the economic drama. As introduced by researchers at Deutsche Bank, meet “Quantitative Tightening,” the pesky, problematic, and much less disciplined kid brother of “Quantitative Easing.” Now that QE is ready to move out…QT is prepared to take over.
For much of the past generation foreign central banks, led by China, have accumulated vast quantities of foreign reserves. In August of last year the amount topped out at more than $12 trillion, an increase of five times over levels seen just 10 years earlier. During that time central banks added on average $824 billion in reserves per year. The vast majority of these reserves have been accumulated by China, Japan, Saudi Arabia, and the emerging market economies in Asia (Shrinking Currency Reserves Threaten Emerging Asia, BloombergBusiness, 4/6/15). It is widely accepted, although hard to quantify, that approximately two-thirds of these reserves are held in U.S. dollar denominated instruments (COFER, Washington DC: Intl. Monetary Fund, 1/3/13), the most common being U.S. Treasury debt.
Initially this “Great Accumulation” (as it became known) was undertaken as a means to protect emerging economies from the types of shocks that they experienced during the 1997-98 Asian Currency Crisis, in which emerging market central banks lacked the ammunition to support their free falling currencies through market intervention. It was hoped that large stockpiles of reserves would allow these banks to buy sufficient amounts of their own currencies on the open market, thereby stemming any steep falls. The accumulation was also used as a primary means for EM central banks to manage their exchange rates and prevent unwanted appreciation against the dollar while the Greenback was being depreciated through the Federal Reserve’s QE and zero interest rate policies.
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