The politics of quantitative easing and the increasingly negative consequences they have on developing countries

20 August 2018 by Myriam Vander Stichele

QE programs were implemented by the central banks to stimulate the Western economies after the financial crisis of 2008. Central banks bought bonds with newly created money that was earmarked for circulation among the banks and financial markets. The QE programs have culminated in, among other results, rapid capital flows to developing countries due to the higher returns on investment in those countries, and the greater willingness of foreign investors to take risks. This has resulted not only in increased government debt in the form of government bonds from developing countries, but also a dramatic increase in corporate bonds issued by companies in developing countries.

For example, the issuance of international bonds from the Latin American and Caribbean regions increased from US$297 billion in 2009 to US$757 billion in 2017. Some of this debt is held by institutional investors Institutional investors Entities which pool large sums of money and invest those sums in securities, real property and other investment assets. They are principally banks, insurance companies, pension funds and by extension all organizations that invest collectively in transferable securities. in more prosperous countries, often in the form of private pension funds Pension Fund
Pension Funds
Pension funds: investment funds that manage capitalized retirement schemes, they are funded by the employees of one or several companies paying-into the scheme which, often, is also partially funded by the employers. The objective is to pay the pensions of the employees that take part in the scheme. They manage very big amounts of money that are usually invested on the stock markets or financial markets.
that seek higher returns.

A SOMO report by Rodrigo Fernandez explains how QE works, what its consequences are, how it creates serious risks for developing countries and what measures should be taken to prevent their adverse effects. The danger for developing countries has become more acute since the US Federal Reserve FED
Federal Reserve
Officially, Federal Reserve System, is the United States’ central bank created in 1913 by the ’Federal Reserve Act’, also called the ’Owen-Glass Act’, after a series of banking crises, particularly the ’Bank Panic’ of 1907.

FED – decentralized central bank :
and the European Central Bank Central Bank The establishment which in a given State is in charge of issuing bank notes and controlling the volume of currency and credit. In France, it is the Banque de France which assumes this role under the auspices of the European Central Bank (see ECB) while in the UK it is the Bank of England.

European Central Bank
The European Central Bank is a European institution based in Frankfurt, founded in 1998, to which the countries of the Eurozone have transferred their monetary powers. Its official role is to ensure price stability by combating inflation within that Zone. Its three decision-making organs (the Executive Board, the Governing Council and the General Council) are composed of governors of the central banks of the member states and/or recognized specialists. According to its statutes, it is politically ‘independent’ but it is directly influenced by the world of finance.
) have decided to discontinue their QE programs while increasing interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
, which results in investors siphoning capital from developing economies, back to the US in particular
The danger for developing countries has become more acute since the US Federal Reserve and the European Central Bank (ECB) have decided to discontinue their QE programs while increasing interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. rates, which results in investors siphoning capital from developing economies The lack of debt-resolution mechanisms, for both government bonds and the great number of corporate bonds Corporate bonds Securities issued by corporations in order to raise funds on the Money Markets. These bonds resemble government bonds but are considered to be more risky than government bonds and other guaranteed securities such as Mortgage Backed Securities, and therefore pay higher interest rates. , will make any looming debt crisis more difficult to manage. This might, as in the past, result in painful adjustments by the indebted countries, and saddle ordinary citizens with dramatic, long-term socio-economic and political consequences. There are a variety of measures that could be enacted to mitigate the negative effects of QE and the resulting ever-greater, more aggressive, fluctuations of cross-border capital inflows and outflows. These include: capital controls for specific capital flows, the reregulation of financial markets, third-country cross-border transaction taxes, increased risk assessment methodologies prior to the purchase of a developing country’s debt as well as the introduction of debt-restructuring clauses in corporate bond Bond A bond is a stake in a debt issued by a company or governmental body. The holder of the bond, the creditor, is entitled to interest and reimbursement of the principal. If the company is listed, the holder can also sell the bond on a stock-exchange. contracts.

The adverse effects of QE have already been felt by a number of developing and so-called emerging market countries, especially Turkey, South Africa, Brazil, India, Indonesia and Russia. Their currencies have already undergone dramatic depreciation, prompting a negative impact on both their economies and their citizens. For instance, Argentina’s peso, economy, debt situation and government policy have come under such intense market pressure, including the withdrawal of investors’ capital, that the Argentine government was forced to seek a US$50 billion loan from the IMF IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.
to avoid defaulting on its debt.

Another country that has suffered from the discontinuation of QE is India, whose currency reached an all-time low at the end of June 2018. Kavaljit Singh, in a recent article, describes why the Indian rupee has depreciated so much and what the consequences of this depreciation are. Singh explains why a weaker rupee is detrimental to the Indian economy and Indian consumers. The weaker rupee will probably not boost exports because the Indian economy is very dependent on imports of foreign inputs that need to be paid in dollars, including in the energy sector. Singh further describes what kinds of measures India’s central bank has taken thus far in 2018 and in the past against the rapid withdrawal of capital, which have thus far been inadequate. A new problem in India is the increasing debt held by companies, also in other emerging market countries, as Singh describes in the section on the Argentine crisis. Improved international policy coordination on monetary and financial policies could be a solution, but the G20 Ministers of Finance failed to make any significant progress on this issue during their meeting in Buenos Aires on 20-21 July 2018.




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