Quantitative easing and its effect on the dollar
Today's Financial News - Posted December 12, 2008
The parlous state of the US financial system should, in theory, be reflected in a lower value of the dollar, had it not been for its hegemonic reserve currency status propping the dollar up during this deleveraging phase.
by Stephen Jen
Baltimore — (TFN): The Fed has commenced QE (quantitative easing). In this note, we review the concept of QE and analyse the likely impact of this extraordinary operation on the dollar.
The upshot is that, since monetary policy, including QE, is a ‘nominal’ operation, the operation itself should not have significant implications for the real value of the dollar. The nominal dollar value should, thus, only be affected if QE alters the outlook of inflation in the US over the medium term. Also, whether QE by the Fed should erode the value of the dollar should be assessed relative to what other central banks do.
To the extent that the European Central Bank (ECB) and the Bank of England (BoE) also conduct QE – which is the case – the impact of QE on the dollar is not necessarily negative. Having said this, though QE per se should affect the dollar through relative inflation as well as inflation expectations, the underlying structural problems that forced the Fed to conduct QE in the first place should alter the fundamental value of the dollar, relative to those of other currencies.
The parlous state of the US financial system should, in theory, be reflected in a lower value of the dollar, had it not been for its hegemonic reserve currency status propping the dollar up during this deleveraging phase. The bloated fiscal deficits (which we assume will exceed those of the G7 countries) will further weigh on the intrinsic value of the dollar.
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