Recent weeks have seen several Asian policy makers criticize the United States for its monetary policy. "The US is printing too much money", goes the argument. "The low interest rate policy is going to drive asset bubbles in Asian markets". But how realistic are these claims? Is the Federal Reserve capable of creating bubbles elsewhere in the world?
No.
If bubbles come (and come they might), they will be caused by domestic policy makers' decisions. The economists that make up the FOMC of the US Federal Reserve are beyond reproach. Economists are normally beyond reproach, as a rule.
The first line of attack against the Fed is that the central bank is printing too much money, and this excess liquidity is going to spill over into asset markets elsewhere in the world.
Hong Kong property, or Australian equities, or whatever asset class one chooses to name, are vulnerable to the rise in US liquidity. This argument can be swept aside with remarkable ease. US money supply influences US asset prices and nothing else.
A US dollar is simply a claim on US goods, services and assets. One can not buy property in Kowloon or equities in Shanghai with US dollars (one needs Hong Kong dollars or Chinese Renimbi respectively).
The US dollar can buy equities quoted on the New York Stock Exchange. US dollars can buy property in California.
However, the US equity market does not look like a bubble, and the Californian property market is the very antithesis of a bubble - it is a bubble that has burst.
If the Fed's printing presses are not creating bubbles in its domestic markets, how are they supposed to be blowing bubbles elsewhere in the world?
The answer is, of course, that Fed money creation is not doing anything directly to markets elsewhere in the world. Someone who comes into possession of dollars, and who wishes to buy assets in Asia, must first convert those dollars into the appropriate Asian currency.
If the exchange rate is floating, and the Fed is genuinely creating too many dollars, then the value of the dollar will fall against the Asian currencies. In that case, a dollar will buy fewer and fewer Asian assets, and have less and less ability to create a bubble.
If through a peg, semi-fixed exchange rate or a currency board the Asia-US exchange rate is not allowed to shift, then the dollar will have potency.
However, the critical transmission here is not the Fed's policy. The transmission of US liquidity to Asian asset markets is the fixed exchange rate regime, which is not the choice of the Federal Reserve.
If local monetary policy makers keep a stable exchange rate, they are surrendering control of their domestic monetary policy to a degree. That act of surrender does risk bubble creation - but it is hardly the fault of Bernanke and his colleagues.
If not through the printing of money, can the Fed be accused in other ways? The phrase "carry trade" has been voiced by some.
The suggestion is that hedge funds and other speculators are borrowing in dollars (at very low interest rates), and then racing off to buy assets outside of the United States without regard to the fundamental value of those assets (who cares about values, if the funding cost is negligible?).
A good rule in financial markets is that the accusation "it's the carry trade that is doing it" is generally uttered by a commentator who no longer knows what is going on.
The "carry trade" is a wonderful explanation, because it is impossible to measure in real time (and extraordinarily difficult to measure even after the event).
As such the irresponsible can claim a "carry trade" is driving markets without fear of convincing contradiction: nothing can be proved one way or the other.
Having said that nothing can be proved, however, it seems relatively unlikely that a large scale leveraged (borrowing financed) carry trade is being run out of the United States.
The whole problem with the US financial system is that institutions remain highly reluctant to lend money. If no one will lend, how are carry traders able to borrow?
Of course, investors can decide to sell dollars and move into other asset markets without borrowing money - an unleveraged trade. That seems to be a plausible argument for capital flows at the moment.
However, this trade is motivated by expected relative returns, not by cheap funding costs (because no funding is involved). Fed policy is not a direct part of the process.
What the Fed has undoubtedly done is reduce some of the risk that was evident in markets back in February or March of this year.
By reducing risk, the Federal Reserve has made risk assets more attractive - and that will affect valuations. But this is fundamental, and to be welcomed. Asian policy makers can hardly be advocating an increase in risk as a desirable strategy.
Asian policy makers should stop trying to deflect future criticism. If bubbles appear in the Asian region, it will be because of the decisions of Asian policy makers.
Asia controls its own financial destiny; it does not have to be subject to US policy. Bernanke and his colleagues are innocent bystanders.
The writer is Deputy Head, Global Economics, UBS Investment Bank
