The Fed shocked currency and stock markets with fresh signs that it may begin to ease of its support for the U.S. economy by rolling back its quantitative easing efforts at the end of the year. It’s well known that the Fed has been considering such a move, but this is one of the few times that it has hinted at a specific timeline. While the Fed’s moves may be largely targeted at the domestic economy, it will have implications for economies around the world.

Fed

With the rise of floating interest rates and fiat currencies, the globalization of business processes, and increased international capital flows, the impacts of fiscal and monetary policy decisions in one country can have huge impacts on the entire global economy. For no other country is this more true than for the United States, still by far the world’s largest economy. With the U.S. contemplating changes to its fiscal and monetary policies, leaders and investors around the world will certainly be watching closely.

The Fed’s Plan to Ease QE by the End of 2013

Fed Chairmen Ben Bernanke has announced plans to roll back the United States quantitative easing efforts by the end of the year, assuming that the American economy continues to improve. This move will likely strengthen the dollar and also decrease the amount of capital flows originating in the United States. Many analysts have already pointed out how cheap money supplied by the Fed has led to rising stock markets not just in the United States, but across Asia and the rest of the world. Now a reverse in course could reverse gains made in financial markets.

Bernanke also stated that the Fed has no plans to increase interest rates in the near future, though that too may change if the U.S. economy continues to regain strength. These moderate steps could hopefully lead to stable financial markets, but at a time of economic uncertainty, nothing should be taken for granted. This is especially true for many Asian nations, which have not forgotten the havoc caused by the 1997 Asian Financial Crisis.

Financial and Investment Impacts in Asia

Financial leaders from across the world, including South Korea, Eastern Europe, and emerging Asia have already stated that America should show temperance when rolling back fiscal and monetary policies. Many leaders seem to be afraid that a roll back on quantitative easing will not just cause the dollar to rise, but also that it will stem capital inflows. In fact, there’s a strong risk that capital flows will reverse and money will start to flow out of emerging economies. A similar scenario helped create the 1997 Asian Financial Crisis that wreaked havoc in Asia.

Already, stock markets across Asia have recoiled. The Jakarta Composite index plummeted by 3.7 percent. The Philippines PSE composite fell by 2.9 percent and Thailand’s SET exchange fell by 3 percent. Singapore’s Straits Times Index fell by a more moderate 2.5 percent, while Malaysia’s Bursa exchange only suffered a .59 percent drop.  Even larger nations have been roiled by the announcement. China’s Shanghai Index by 2.8 percent and Hong Kong’s Hang Seng Index lost 2.9 percent.

Emerging nations in Asia and elsewhere have found themselves enjoying increased capital flows, which have pushed up stock markets and increased local investment.  While local governments have been trying to moderate capital inflows, they have also largely embraced increased investment and interest from international investors.  These inflows have increased local investment and have helped spur strong economic growth but the party may soon come to an end.

Now, the spigot for cheap money may be shut off. This will strengthen the dollar and weaken local currencies. It could also lead to increased, if not massive, capital outflows which could depress local markets and potentially even cause financial emergencies. If the dollar rises and cheap cash is no longer available, financial institutions will be tempted to pull their money back to the U.S. to enjoy a stronger dollar and higher interest rates.

Already, investors have begun to sell off bonds in Asia and Europe. Liquidity is starting to become an issue in emerging markets, which have relied on cheap American dollars to lubricate their financial markets. While the Fed still appears to months away from any dramatic action, there is a risk that investors could start to stampede towards the exit. This could send local financial markets plummeting.