The Fed's return to quantitative easing threatens to create a glut of liquidity reminiscent of the mid-2000s savings glut. It is likely to inflate bubbles, notably in the fast-growing emerging world.
As well as harming the U.S.’s ability to take the high ground with China, quantitative easing will test the world's commitment to an open international economy. Already, countries from Brazil to Thailand have responded to the flood of incoming capital by imposing controls and taxes, retreating from the idea of financial globalization. To make capital controls stick, these countries may find they need to intervene heavily, policing the activities of multinational companies that are suspected of funneling capital illicitly between subsidiaries. Likewise, the new capital controllers may demand the right to police trade invoices, since over- or under-invoicing is a time-honored method for circumventing capital controls.
None of this might matter if next week's G20 summit were on track to succeed wonderfully. But the Fed's super-loose policy is straining the international monetary order at a time when the spirit of international cooperation looks particularly limp. Across the rich world, leaders have been weakened by a sluggish economy that has dragged down their poll ratings, undercutting their appetite for making unpopular concessions to foreigners.
Even before the Fed's action this week, there was much loud talk of currency war. This now seems sure to intensify, and the United States has lost its moral authority to broker currency peace.
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