Quantitative easing (QE) refers to large-scale asset purchases by the US Federal Reserve to inject liquidity in the world’s biggest economy after the onset of the global financial crisis in late 2008. In September 2012, stubbornly high US unemployment and faltering economic growth prompted it to launch QE3, under which it planned to buy US$40 billion worth of bonds per month, with no set end date. As of late 2012, it had bought some US$2.3 trillion in long-term securities. In December 2012 it announced it was increasing its purchases to US$85 billion a month.
Bernanke's shock announcement signals new economic sobriety
The power of words! With his brief statement that it would be "appropriate to moderate the monthly pace of purchases later this year", US Federal Reserve chairman Ben Bernanke sent global financial markets - for equities, commodities, bonds and foreign exchange - into a tailspin.
That he feels comfortable enough to tell markets of his timetable for "tapering" the Fed's extraordinary US$85 billion monthly bond purchases shows his optimism about the direction of the US economy, though he tempered his statement with the promise of continuing the third round of the US central bank's quantitative easing programme (QE3) should economic conditions sour. But, for now, he argues, the downside risks to economic activity in the US have significantly moderated and the euro-zone crisis has abated.
So why are markets so fearful, as if they are facing the onset of another crisis rather than general economic improvement and a possible return to normalcy in the United States? Quite simply, Bernanke has announced he will slowly but surely take away the punch bowl, although not yet. Markets do not like the easy money being taken away from them. The Fed chairman has been very friendly to risk-asset markets since the onset of the global financial crisis, with the famous "Greenspan put" being replaced by the "Bernanke put", in which interest rates were lowered or liquidity raised. QE3 was once called QE Infinity because many assumed - wrongly as it turns out - his commitment was open-ended. As a result, there has been froth, and even asset bubbles, especially in emerging markets.
Still, some markets reacted rationally. The spike in the yields of US Treasuries as well as other sovereign bonds is to be expected. The outflow from Asian emerging markets and Hong Kong should not surprise anyone, as the easy money created by QE3 has flooded those markets. The slowing of the Chinese economy is another cause for alarm for these regional markets.
But much market pessimism is getting ahead of itself. The slowdown in China - and the ongoing credit crunch there - is accepted by the central government to reduce chronic industrial overcapacity, discipline the banking sector and rebalance the economy towards more consumer spending over export reliance. The world has to accept the era of double-digit growth for China is over. In the meantime, we should welcome the return of the world's largest economy to normality. Let's hope Bernanke is right.