The usual starting point for talking about QE these days, whether you’re for or against it, is that the ECB and Japan are continuing to provide global liquidity while the Federal Reserve and the Bank of England scale back on their own policies. But Societe Generale chief global strategist Albert Edwards argues that by ignoring what’s going on in emerging markets the market is missing a much larger policy shift.

“With the markets so focused on the ECB’s QE announcement, investors are missing the liquidity tourniquet that is strangling the global economy,” he writes (emphasis his). “The ECB may be adding €1tr of liquidity over an 18-month period, but global FX reserves have shrunk at that annual pace over the last six months alone!”

global fx reserves Albert Edwards

FX intervention is the same as QE, says Albert Edwards

While Albert Edwards isn’t exclusively talking about China, it’s probably the most important factor in falling global FX reserves and serves to illustrate the point. When the dollar is falling, as it has been for most of the last three decades, China has kept its own currency weak by printing money and buying dollar assets, something that Albert Edwards says is really no different than QE. But now that the dollar is rising (recently breaking through the 30-year downtrend), this kind of FX intervention is no longer necessary. It’s possible that some emerging markets could even reverse course to prevent their own currencies from falling too rapidly relative to the dollar.

China fx reserves USD breaks downtrend

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Tighter global liquidity would threaten emerging markets

Global FX reserves have been loosely correlated with commodity prices in recent years, and Albert Edwards suggests that falling commodities prices may be the first sign of tightening global liquidity, which would explain the timing of the collapse in oil prices.

commodity v FX reserves

But Albert Edwards would also expect emerging market stocks to suffer a similar decline, and that hasn’t happened, at least not yet.

“Russell Napier has pointed out that investors continuously underestimate how closely the EM boom and bust cycle is linked to the ebb and flow in their BoP situations (which mirrors the FX reserve situations),” he writes. “Frankly I am most surprised that EM assets still remain so resilient in the face of a sharp downswing in FX accumulation.”

This gives Albert Edwards’ fellow bears something to watch out for in the months ahead. If a balance of payments crisis kicks off in the emerging markets, tighter global liquidity may be the culprit despite the latest round of developed market QE.

EM v fx reserves

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