Will the Fed's Quantitative Easing Enrich Asia?

Just as leaves on a plant turn toward sunlight, capital seeks out the highest returns. The Fed's recently renewed quantitative easing program will dump $75 billion a month of printed money into the financial system between now and Sept. 30, 2011. That money will go somewhere, and overseas is a very likely destination.

The mechanism for this journey is the carry trade: speculators borrow dollars at the ultra low rates provided courtesy of the Fed, convert those dollars into the currency of a nation where higher returns are available, and invest in that nation. Since the highest returns generally available these days are in Asia, carry trade dollars will head across the Pacific. If higher returns were available in America, these dollars wouldn't go west. But the stagnation here makes Asia appear sunnier.

Some of the dollars will likely be invested in China, stimulating its already red hot economy. China, however, maintains currency controls that prevent unlimited capital inflows and outflows. Consequently, some carry trade dollars will flow to other Asian nations, stimulating their economies.

The carry trade has worked the other way. In the first half of the past decade (around 2001 to 2006), the Japanese central bank lowered interest rates to zero and tossed in some quantitative easing to boot, in a largely futile effort to revive Japan's economy. Speculators borrowed yen cheaply, converted it into currencies of nations with higher interest rates and invested in those nations to profit from the difference between national interest rate levels. America was a one beneficiary of the yen carry trade. Possibly, Japan's quantitative easing, leaving behind the stagnation in its native land, contributed to America's recent real estate and credit bubbles. Now, the Fed's quantitative easing is sparking fear in Asia of asset bubbles and heightened inflation.

Presumably, the Fed is aware of the potential for its quantitative easing program to stimulate other nations instead of America. Perhaps it hopes that juiced up Asian nations will import more from American exporters. That probably will happen to some degree. But there's no way of knowing how much benefit America will receive from such a circuitous route.

With the dollar being the world's reserve currency, the carry trade is easily done and easily unwound. Its biggest up front risk may be a revival of the dollar. But with the Fed publicly committed to quantitative easing, a strengthening of the dollar seems about as likely as confirmation of the Yeti.

The more ebullient carry traders become, the less likely quantitative easing will help America. Much of the Fed's big money dump could simply fly away overseas. Then what?