Dancing the monetary jig

Conventional economic wisdom states that if workers try their hardest, society as a whole will benefit. But in reality, things rarely work out so neatly. Individual actions can end up doing more harm than good for the broader community. The global economy is in a pitiful state right now. Europe, the United States and Japan have all announced expansionary monetary action plans.

On Sept. 6, the European Central Bank agreed to launch an unlimited bond-buying program to help struggling euro zone states avoid a deeper crisis by easing their borrowing costs.

One week later, the U.S. Federal Reserve announced that it has begun a third round of quantitative easing and would purchase $40 billion in mortgage-backed securities each month. Japan followed in their footsteps last week with a synchronized stimulus move by raising the cap on purchases of government bond by 10 trillion yen ($127.9 billion).

The emergency measures underscore the grave dangers the world’s major economies face, and the urgent need to save them from disaster. The European economy contracted in the second quarter, and the U.S. and Japan are also struggling with the risk of entrenched stagnation. They need to employ all possible fiscal and monetary weapons, but with their public finances deeply in the red, easing liquidity is viewed as the last viable option.

However, making more money available also brings with it tremendous risks. The influx of money from advanced economies will spill over into emerging markets and rock their bond and equity bourses. Volatility in the foreign exchange market can also raise the risk of currency crises in emerging economies due to the swings created by profit-seeking foreign capital and speculative hedge funds. Sharp currency appreciations can hurt exports and badly damage national economies.

This is precisely why emerging economies are voicing concern over the U.S. money-easing measures, which will lower the value of the greenback and hurt their capital markets and product competitiveness. Brazilian Finance Minister Guido Mantega declared that Brazil will continue its “currency war” to defend itself from the impact of low-yielding dollar assets, and China has also joined in the chorus of criticism. Japan countered by having its central bank raise its asset-purchasing fund to 55 trillion yen from 45 trillion yen to slow the rise of the yen. But critics say the quantitative actions could worsen the growing signs of protectionism amid economic stagnation.

As all this bodes poorly for Korea’s export-dependant and slowing economy, the government should act firmly to fend off financial volatility.