The Fed’s Taper Effect on Frontier Markets and Virtual Currencies

by Georgi Ivanov

A largely unnoticed message from the Chinese Central Bank in late November has raised questions about the upcoming tapering of the Federal Reserve’s quantitative easing (QE) initiative, which would mean an end to the monthly $85 billion of fresh money that enter the American monetary system. Signals about the end of the Fed’s stimulus package began in 2012, and were supposed to end in the fall of this year. However, the Bernanke and co unexpectedly announced that the policy shifted gears and QE is now supposed by the middle of 2014. Good news on unemployment levels of the US and stronger-than-expected economic growth say that it will likely be the case, but the new army of low-end service workers is not a signal of a sustainable recovery. Should the stock market crash from its historic highs, we’re back in the economic gutter and policymakers will be clambering up the steps of the Fed with the proverbial chipped bowl and a “Can I please have some more, Sir?”. Well, Ma’am, when Janet Yellen takes over.

The economic rationale for QE was to promote lending through access to cheap, fresh capital, with the idea to continue it until the unemployment rate falls below 7%. Meanwhile, interest rates would remain depressed at, basically, nothing, until unemployment dips below 6,5%. Officially, there should be at least two quarters of sustained growth before any of this, and November’s job numbers of 203,000 additional payrolls are hopeful. All the same, however, the optimism is not reflected in economic forecasts for 2014, with growth expectations for the world economy at 3,6% (IMF) for next year, but the OECD already took it down from 3,6% to 2,7%. Unemployment recovery remains high, public debt has not been resolved, which hints at further austerity and a smooth slip into negative territory.

Global markets also depend on the Fed’s cheap money to attract investment and consequently, growth. Emerging markets are dependent on the inflow of these dollars, and turning off the tap may inadvertently put current account balances in the red around the world. Since the Fed pumps almost a trillion dollars into the global financial system in a year, or approximately 2% of global GDP, the effects can indeed be significant; a potential recession in the developing world will be most likely felt in the West.

The greater issue is that should the Fed not taper off its stimulus, the inflationary risk on the dollar increases significantly and especially since the Chinese yuan overtook the Euro as the second-most traded currency after the USD. The trend continues with another recent announcement by China’s central bank that it is going to enforce a ban on all business entities operating in China from using Bitcoin as a medium of exchange. In a word, the policy of emerging powers is to create regional zones, where transactions in goods, services and currencies take place outside the scope of the USD.

The advent of digital currencies, like Bitcoin and Litecoin, can have a destabilizing effect on the power balance of the global financial system. The threat to the status quo they pose is that, unregulated, virtual currencies can produce an extremely volatile bubble that may inflate, then collapse and re-inflate as capital is reshuffled between currencies in an emerging market. Effectively, a virtual currency is different for the lack of central bank oversight that its traditional cousins have, which also is a factor for its unpredictable behaviour. While the magnitude of virtual currency use may not be very large, expressed in dollar value, it has the potential to create a parallel economy of great scope and complexity, where merely banning it will only succeed in pushing a large portion of legal businesses into the grey economy. It’s like the Silk Road 2.0 of currencies, or like the toss-up on who launders the dug revenue in Afghanistan – us or the Russians – we know it’s there, but it’s taboo.

The point is this: the world is going in a direction where currencies are going to be democratized and there will not be a single entity in control of how fundamentally important goods are traded. If today oil is only bought and sold in dollars, within the next generation, many brands of oil might be bought and sold in dollars, yuan, euros or a virtual currency. The Fed will likely respond by keeping demand for the dollar high and its price low, despite a commitment to taper off by 2014, until the inflationary pressure from lower obligations purchases forces the end of the stimulus program.

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