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Have no fear: The greenback won’t be debased

Speculation is growing that another round of quantitative easing could be announced when the U.S. Federal Reserve meets Dec. 12.

If so, the prospect of more monetary stimulus will bring a queue of people decrying the potential dangers.

Many of these critics believe that QE is intended to debase the U.S. dollar by driving capital into other countries, leading to appreciation of foreign currencies.

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Some believe the ultimate goal is to make U.S. exports more attractive, especially in comparison to those from emerging markets.

The critics should relax, according to a recent report from the Bank of Nova Scotia.

In the report, economists Derek Holt and Dov Zigler examine the flows of private capital into emerging markets over the past 32 years and find that it surged over much of the past decade – well before the Fed began doling out rounds of quantitative easing to stimulate the U.S. economy.

"Those capital flows [into emerging markets] would have largely occurred irrespective of U.S. monetary policy," the authors write.

In fact, the first surge took place in late 2006, before Ben Bernanke announced the first round of QE.

The primary driver of this trend doesn't appear to be any growing fear that the U.S. dollar is on the verge of debasement, but the simple reality that developing countries are growing rapidly and thus are hungry for capital.

If you chart capital flows as a percentage of GDP, the amounts flowing into emerging market and Asian economies have fluctuated in line with the economic growth of these nations, not with rounds of QE.

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The debasement theory also fails to account for the fact that many of the normal channels for monetary policy are broken, the Bank of Nova Scotia authors say.

While U.S. money supply has grown rapidly, the increases have been largely being neutralized by rising levels of bank reserves held with the Fed.

Mr. Holt and Mr. Zigler argue that it's tough to debase a global currency.

"U.S.-dollar denominated Treasuries play a fundamental role as a global funding and liquidity management vehicle," they say.

This makes it difficult for foreigners to escape the currency as easily as they might, say, the Mexican peso.

The real question, according to the Bank of Nova Scotia duo, is whether QE will help the U.S. economy enjoy a strong recovery.

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If it does, emerging markets will benefit from growing American demand for their products.

For now, "it's hard to arrive at a positive scenario for emerging markets, or for that matter global developed markets, that doesn't involve a recovery of the U.S. economy – which needs all the help that it can get."

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About the Author

Josh O’Kane is a reporter with The Globe and Mail's Report on Business. Since joining the paper in 2011, he has told stories from New Brunswick to Nairobi. More


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