Since the September 13 announcement of QE3, I have been attempting to parse out the domestic market implications of the Fed's additional MBS purchases, but an even broader analysis is necessary. QE3 represents a fundamental shift in the Fed's objectives, but the Fed is not unique in this action. Central banks around the world are taking similar steps to bolster their economies. All of these stimulative central bank policies are part of a coordinated effort to combat a global economic slowdown, but they also have currency and trade implications.
In the last few months, the ECB has announced a massive bond buying program and has begun hinting at leveraging the ESM to make the most of their stimulus. The Bank of Japan has followed suit and expanded its stimulative asset purchase fund by 10 trillion yen ($126 billion). Similarly, the People's Bank of China has actively reversed their movement toward currency parity and aggressively pumped liquidity into their market by reducing rates and lowering bank reserve requirements. Even The Bank of England has unveiled several plans to complement their existing QE measures by stimulating lending in joint public-private ventures. So, where does the Fed stimulus fit into all of this?
The Fed's additional QE does little to stimulate lending or increase the velocity with which money is moving around the market, but QE does flood more cash into the system. Since most businesses continue to have unusually large cash reserves, this added money is likely to do little to promote lending and far more to increase inflationary pressure. However, given the global growth slowdown, this pressure might be necessary. More to the point, given that most other countries are also engaging in monetary stimulus, without further Fed stimulus to keep pace with Europe, China, and Japan, the value of the dollar would likely rise precipitously.
Some "strong dollar" advocates might think that such a rise in the dollar would help the economy, but it would devastate domestic manufacturing, harm exports and weaken equity markets. So the Fed has entered a global arms race aimed at devaluing currency under the auspices of monetary stimulus. Since these currencies are measured against one another and global growth continues to be weak, the relative value of the dollar is unlikely to drop much through this whole process. In essence, by acting in concert, central banks around the world are providing stimulus and attempting to weaken their currencies to strengthen equity and manufacturing export markets, but since everyone is doing the same thing, we are basically treading water.
The ultimate outcome to this coordinated global stimulus is that markets are more dependent than ever on central bank action and this will not change in the near future. As it stands today, the velocity of money is at its lowest point in the information age and the Fed's own data demonstrates that credit markets are only operating at a quarter the volume they were at in 2007. So the next big moves will have to be an effort to get money moving around the system faster. Investors should look for opportunities to buy in industries and emerging businesses where freer capital and access to cheap credit will increase profit margins dramatically.