Asset bubbles, a reckless Fed and a threat to dollar hegemony

The Federal Reserve’s decision on Wednesday to pump an additional $600 billion (£370 billion) into the US economy has sparked a wave of anxiety among financial commentators.

Pundits fear the fresh round of quantitative easing – in which the Fed will create money to buy long-dated government bonds – is likely to create new asset bubbles, may fail to revive the sputtering US economic recovery and could further erode the country’s global stature.

Mohamed El-Erian, chief executive of the bond fund Pimco, warns in the Financial Times that without meaningful structural reforms, part of the Fed’s liquidity injection will leak out of the US and result in ‘yet another surge’ of capital flows to other countries.

He notes that emerging economies such as Brazil and China are already close to overheating, and that neither the eurozone nor Japan can afford further appreciation in their currencies.

El-Erian writes that the move, dubbed ‘QE2’ after the Fed pumped $1.75 trillion into the US economy at the height of the global economic crisis, may also speed up the gradual erosion of America’s central role in the global economy – including as the ‘provider of both the world’s reserve currency and its deepest and most predictable financial markets.’

Jeremy Warner, assistant editor of the Daily Telegraph, agrees that dollar hegemony has never before been so much under threat. He writes that the Fed is ‘recklessly’ throwing away the privilege of being able to borrow at will in its own currency from the rest of the world, and at favourable rates.

‘By flooding the world economy with yet more freshly minted dollars, America further undermines faith in the greenback as an internationally reliable store of value and is thereby squandering an economic and geo-political asset of huge importance to the nation's history,’ Warner says.

Elsewhere, Larry Elliot, economics editor of The Guardian, points out that Fed chief Ben Bernanke’s determination to avoid deflation could be leading him to repeat the mistakes of his predecessor.

‘Like Alan Greenspan before him, Bernanke is concerned that disappointing the money men of New York would lead to a market crash,’ Elliot writes.

Citing recent better-than-expected economic news from the US, he adds that Bernanke could be repeating the mistake made by Greenspan in 2003 of keeping monetary policy too loose for too long, adding to commodity speculation and fostering a potentially devastating bond market bubble.

Meanwhile, in a tongue-in-cheek piece, Alen Mattich pens an article in the Wall Street Journal that purports to be what Bernanke meant to say in his opinion piece in the Washington Post.

‘[The policy] also sends shares rocketing. We are very, very good at making shares go up a lot. By making shares go up, we make people feel rich. And the richer they feel, the more they spend,’ Mattich writes, aping Bernanke.

‘Ah, you might say, didn’t we play that game in the late 1990s and then again in the years leading up to 2007?’