Hang on to your hats, Hong Kong. Later today, the Federal Reserve is set to throw the switch on the presses once again and begin printing vast quantities of US dollars. The Fed's announcement won't put it quite like that, of course. But with unemployment not far off 27-year highs at 9.6 per cent, economic growth prospects dim (see the first chart) and inflation minimal, the Fed is widely expected to launch a fresh round of quantitative easing - dubbed QE2 by the market. This involves the Fed buying a large quantity of US government debt - say US$500 billion - effectively printing money in a last-ditch attempt to push down long-term interest rates to try to jump-start economic activity. Whether or not QE2 will revive the US economy remains to be seen, but the precedents are not encouraging. The Fed's first round of quantitative easing from late 2008 to March this year obviously didn't do the job, and when Japan tried something similar between 2001 and 2005, the results were mixed at best. With demand in the domestic economy depressed, most of the money printed by the Bank of Japan simply ended up back at the central bank on deposit as excess reserves. The Bank of Japan's balance sheet ballooned, but the Japanese economy remained stagnant. The fear now is that the Fed, just like the Bank of Japan, may find itself pushing on a string. With US households still deleveraging after their 10-year credit binge, private demand may well stay depressed, no matter how much money the Fed prints. But if QE2 ends up having little effect on the US economy, one place it is likely to have a big impact in is Hong Kong. The idea behind quantitative easing is to push down the yield on US government bonds. Lower long-term interest rates may or may not succeed in encouraging economic growth, but they do make government debt less attractive to investors. And low yields on government bonds also pull down the yields on other types of US debt, which makes that less attractive as well. As a result, US dollar-denominated debt in general becomes less appealing to investors, who naturally look for somewhere else with higher potential returns to park their money. Top of their list is Asia because it offers better long growth prospects than the developed economies of the rich world. So, when the Fed resumes printing money, capital is expected to begin flooding into the region in even greater quantities than it is already. That's likely to cause problems, pushing stock and property prices to unsustainable heights and possibly fuelling consumer price inflation around the region. In response, even the International Monetary Fund, formerly a staunch supporter of free capital flows as a key pillar of economic growth, is now recommending that regional governments look closely at imposing some form of capital account controls to help them manage the expected influx of funds. For Hong Kong, however, capital controls are not an option. Free movement of capital is guaranteed under the Basic Law, the city's mini-constitution. As a result, there is little the authorities can do to stem the incoming tide. During the Fed's last episode of quantitative easing, money cascaded into the city's financial sector, tripling the size of its monetary base (see the second chart). The effect was felt most keenly in the property market, where the slump initiated by the financial crisis was brought to a dead halt, with home prices shooting up again by almost 40 per cent before the Fed finished its first round of money-printing (see the third chart). A similar increase now would push local property prices up to 20 per cent above their level at the height of the 1997 bubble. Anxious to prevent a repeat of the crash that followed that boom, the Hong Kong Monetary Authority is likely to resort to what finance geeks are calling 'macro-prudential measures'. In other words, it will slap fresh curbs on mortgage lending, probably by raising required down payments even further, reducing permitted loan-to-value ratios and strong-arming the city's banks into being less generous with their property loans. But although such measures might help prevent the banking sector from overextending itself, they are unlikely to prevent a renewed surge in property prices on the back of any fresh wave of capital inflows. If QE2 goes ahead, Hong Kong could be sailing full steam ahead into another storm.