Questionable impact of "quantitative tightening"
Coined by our research partner at Deutsche Bank, "Quantitative Tightening" or "QT" describes the secular shift in the trend of foreign currency reserves in the hands of central banks around the world.
Since the early 2000s, central banks have accumulated US$10 trillion of assets on the back of large current-account surpluses and capital inflows. But, until recently, the trend has reversed.
Global foreign currency reserves have peaked at $12 trillion in August, 2014, and began to fall to $11.4 trillion at the end of August, 2015.
The most notable decline was seen in China, the world’s largest reserves holder, which accounts for 30 per cent of global reserves.
The People’s Bank of China (PBoC) sold its dollar assets aggressively in a bid to defend the weakening renminbi, exacerbated by the PBoC’s decision to float the currency on August 11.
Major oil exporters such as Saudi Arabia and Russia also saw their reserves declined in the past several months due to falling revenue following a 50-per-cent collapse in the price of oil.
Other emerging market central banks could also face the same problem as capital outflows accelerated amid stronger dollar and rising interest rate in the US due to the impending Fed funds rate hike.
Deutsche Bank argues that the depletion of central bank’s assets would cause interest rates to rise and global financial condition to tighten. The draw-down in reserve assets, which are heavily concentrated in global fixed income securities, could trigger a sell-off in safe-haven assets, pushing up bond yields, especially in the developed markets.
Thus, QT would at least partly offset the attempt to provide ample liquidity and suppress market interest rates to stimulate the economy via quantitative easing (QE).
However, some economists disagree with the notion that QT is QE in reverse.
They argue that, as opposed to QE which increases liquidity by central bank’s “printing” of new money, QT does not affect the level of global liquidity.
The capital that leaves central banks does not disappear from the financial system. In fact, it changes hands from the central banks to|the private sector, which could find its way back into developed market bonds.
In this sense, the falling reserves at central banks could have limited impact on global financial conditions.
TISCO Financial Group Plc contributed this article.
