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Impact on the us economy AGENDA FOR THE PRESENTATON The phenomenon of Quantitative easing Long term impact on dollar Impact on commodities & oil prices Impact on Sovereign debt of the developed world Impact on India and China A B C D E F
Quantitative easing-II YOU & I BANK-I CENTRAL BANK BANK-II FIRMS G.D.P SUPPY VELOCITY
Quantitative easing (QE) unconventional monetary policy used by some central banks to stimulate their economy. The central bank creates money which it uses to buy government bonds and other financial assets, in order to increase the money supply and the excess reserves of the banking system. What is Quantitative Easing ?
LONG TERM EFFECTS ON DOLLAR
LONG TERM EFFECTS ON THE DOLLAR
IMPLICATIONS ON US TRADE DEFICIT
Expected effect in the domestic US markets.
IMPACT ON THE US ECONOMY
US GETTING WEAKER OR STRONGER? In view of the current situation the financial position of U.S. is set to weaken. Macro Economic indicators still weak. Lack of confidence in the recovery of the economy. Dollar index reached the lowest point in Q4 2010. Diversification out of the Dollar. Threatfrom Chinese economy.
US GETTING WEAKER OR STRONGER? Rush to dump the U.S dollar and to accumulate gold and other more stable currencies China has already started bilateral trade in Yuan with a number of SE Asian and African countries OPEC may also shift to more stable currencies .
WHAT IS CARRY TRADE ? With a low interest rate Investors would borrow from the US Funds will flow from US to Brazil , invested in to the high yield bonds. US carry trade will take place.
IMPACT ON US CARRY TRADE AND ITS FLOW.
The interest rate near the zero level.
Expected to remain low for a while now.
U.S. carry trade set to increase.
Flight of funds to high interest currencies.
India and China have increased the interest to check inflation.
Brazil, with an interest rate of 10.75 %, provides one of the highest
interest rate differentials against the USD
EFFECT ON COMODITIES
Effect on international commodity prices Commodities are $ denominated thus along with $ the commodity prices are likely to become cheaper in currencies that revalue them. This is likely to make countries like China hoard metal like copper to boost future growth thus increasing its demand. This would lead to speculative buying of commodities Furthermore, with low interest rates and high inflation people like to hedgewith commodities. This would lead to higher commodities prices
Copper is the driver of growth. Low interest rates make bank deposits useless specially if inflation is higher than the rate. This leads to speculative buying of metals. Besides the devaluation of the $ makes it cheap for China to hoard the metal for its industrial ambitions. One should go long on copper. What position Long or Short would you take on Copper?
“JP Morgan revealed as mystery trader that bought £1bn-worth of copper on LME”- The Telegraph; 4th Dec 2010 Bought 350,000 tonnes in reserves This pushed up the price for copper to $8,700, its highest level since the financial crisis in October 2008. A recent example …
Effect on GOLD ? Gold is a hedge against inflation and uncertainty. With low interest rates; slow and uncertain recovery of the US, the gold prices are likely to hold strong.
Uncertainty of USD has prompted countries to shift reserves to gold
All major economies are shifting to gold
Countries are diversifying their Forex reserves
US holds 8,000 tons of gold, the highest in the world
China's gold holdings surged to 1,054 tons in 2009 from 454 tons in 2003. The nation is the world's fifth-largest gold holder.
EFFECT ON OIL PRICES EMERGING ECONOMIES
Effect on oil prices and its impact on both emerging and developed markets?
Devaluation of the Dollar will raise the oil prices.
Rise in crude prices has an inflationary effect.
Therefore, it will slow down growth in the emerging markets.
impact on emerging market currencies and on its economy? Flight of USD to emerging markets has led to appreciation of the local currency. This has ramifications on the exports of the country and overall BOP. Countries are artificially devaluing their currency to pep up exports. US has lately asked China to revalue its currency as they were in a disadvantageous position and threatened to retaliate.
IMPACT ON SOVEREIGN DEBT
Sovereign Debt of Countries
Devaluation of USD Repayment of debt becomes expensive OUTSTANDING INTERNATIONAL DEBT
QE-II EFFECT ON BONDS
Demand for treasury bills likely to go up
Go long as prices are expected to increase
QE-II Impact on the recovery of European Union QE2 will induce excess USD into the US economy This will lead to devaluation of USD against other currencies This is not favorable for exports by EU to US, thus will have a negative effect on recovery.
IMPACT ON CHINA
Impact on Chinese Economy? China artificially maintains a devalued Yuan. There is a limit to the amount of USD which a central bank can hoard. Excessive Yuan in the market will lead to inflation. Thus it is inevitable that China revalues.
impact on CHINA’s Foreign exchange reserves? Due to artificial valuation large assets have been built up in china. It is estimated that about 70 % of China's foreign exchange reserves are invested in dollar assets. A stronger Yuan would intensify this year, attracting "cross-border arbitrage" funds, because of the country's relatively high interest rates
impact on CHINA’s Foreign exchange reserves? Cont.. Proceeds from exports would also rise as global recovery generated demand for Chinese goods With foreign direct investment expected to increase steadily, China will be facing greater pressures from the rising amount of foreign exchange inflows Any sudden revaluation will prompt rapid sale and may cause a bubble effect.
impact on CHINA’s Foreign exchange reserves? Cont..
Gold purchases could help China reduce the risk of holding large volumes of US dollar assets as a major part of its foreign exchange reserves.
Purchases could push up gold prices sharply. Also, the average long-term returns on investment in gold are low.
If China purchases gold on a large scale, prices on the international market price will surge, which would, in turn, affect domestic individual consumers.