Last week, US Federal Reserve Chairman Ben Bernanke delivered a dreary forecast for the US economy. Under a scenario of high unemployment and deflationary concerns, a new monetary stimulus (or quantitative easing - QE) package should be in place after the Federal Open Market Committee (FOMC) meeting on November 2-3 to bolster domestic growth. On one hand, the Fed is going to inject liquidity in order to provide a lifeline to the economy. But on the other hand, it is actually a strategy to deal with China's reluctance to accelerate the pace of yuan appreciation.

Bernanke's statement last week implied a vague inflation target of 2 percent, so a monetary policy of further loosening is likely to be adopted for a protracted period since a bleak labor market and low capacity utilization rates have kept inflation away from the US economy. But an influx of US dollars would drive investors to seek high yielding assets, such as currencies, bonds and equities in emerging markets. These activities will eventually lead to the appreciation of emerging market currencies and impairment of trade balances. To alleviate the pain, emerging economies have started taking measures. For example, Brazil and Thailand decided to tax foreign holders of fixed-income investment; Indonesia has imposed a one-month holding period on sovereign bond instruments; and other export-dependent economies such as Taiwan and South Korea are likely to follow suit.

If history is any guide, the Central Government will not let the yuan rise as fast as the yen did after the Plaza Accord was signed in 1985. Japanese policymakers were brimming with self confidence back then. They simply believed that their economy would benefit from overseas merger and acquisition deals and rising spending sprees. They shrugged off the potentially negative impact of an expensive domestic currency and expected the economy to weather the storm. However, the outcome finally shattered their expectations and the Japanese economy is now still far from showing decent growth more than 20 years since their asset bubble burst. As one of the pragmatic governments in the world, the Central Government should seriously take the Japanese experience as a classic lesson and only allow the yuan to appreciate gradually.

So, who are the victims of QE? China is not likely to be the only economy affected, but will be joined with a group of small and open emerging economies. Emerging economies have experienced currency rallies during the past few months but there is no room for them to be complacent. Exports are losing steam, and upcoming austerity measures in developed countries seem to have further dampened global demand. More importantly, the influx of foreign capital is driving the US dollar lower, forcing those economies to choose between losing competitiveness, or adopting stringent capital controls.

But the measures that have been imposed so far are relatively market-friendly. The words coming out of the mouths of central bankers remain gentle. Neither a trade war nor draconian capital controls are imminent. However, policy risks are indeed mounting. Some government officials, such as those of India, are expressing concern about volatile currencies and do not rule out the possibility of intervening in the forex market if the situation continues to deteriorate. Moreover, encouraging capital outflows is also an alternative to counter currency appreciation. For instance, Thailand has proposed raising the ceiling on overseas property purchases by Thais and tightening onshore foreign currency holdings. China may also follow suit by loosening restrictions on qualified domestic institutional investor (QDII) funds.

We do not expect to see any silver lining after the G20 summit. A comprehensive global agreement like the Plaza Accord is not likely to be reached either as emerging economies are too small to cater for developed countries' needs.

The author is a research manager at Alroy Financial Services Ltd, an independent financial services provider. The opinions expressed here are entirely his own.

(HK Edition 10/28/2010 page2)