Thursday, November 4, 2010

Pimco Says QE2 Likely to Backfire: New Protectionism Will Follow

Mohamed El-Erian, chief executive and co-chief investment officer of Pimco, says the Fed's QE2 will likely backfire because the benefits to the U.S. come with burdens for other countries, and both could have significant unintended consequences.

In an article for the FT, he says the Fed had no choice, and given the excessive publicity around the size of the Fed's move, he is probably right. Too little, the markets crash. Too high, the USD crashes. However, El-Erian calls QE2 a "blunt instrument for the difficult task of restoring growth and generating jobs".
He adds that liquidity injections and financial engineering that the Fed has engaged in are insufficient without meaningful structural reforms. The liquidity injection will flow out of the US and result in yet another surge of capital flows to other countries (causing their currencies to appreciate further).

"The rest of the world does not need this extra liquidity, and this is where the second problem emerges. Several emerging economies, such as Brazil and China, are already close to overheating; and the eurozone and Japan can ill afford further appreciation in their currencies".

New protectionism will follow.

El -Erian concludes that QE2 will be of limited success in sustaining high growth and job creation in the US, and will complicate life for many other countries.

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