Critique of the US Federal Reserve by Kampamba Shula

US Federal Reserve Monetary Policy
We cannot discuss US monetary policy without looking at its history to create a backdrop on which further analysis can be done.
The first question that should be answered is why exactly has the US Federal Reserve been using Quantitative Easing as its monetary policy strategy? Why not use interest rates?
The answer lies in the actual definition of what quantitative easing actually is. Quantitative easing (QE) is an unconventional monetary policy used by central banks to stimulate the economy when standard monetary policy has become ineffective (Bank of England , 2011).
A central bank can implement quantitative easing by buying specified amounts of financial assets from commercial banks and other private institutions. This increases the monetary base and effectively lowers the yield on those financial assets ( Bank of England , 2013).
Expansionary monetary policy to stimulate the economy typically involves the central bank buying short-term government bonds in order to lower short-term market interest rates ( European Central Bank, 2008). However, when short-term interest rates have reached or are close to reaching zero, this method can no longer work ( BBC , 2013).
Quantitative easing may then be used by monetary authorities to further stimulate the economy by purchasing assets of longer maturity than short-term government bonds, and thereby lowering longer-term interest rates further out on the yield curve (Bernanke, 2009). Quantitative easing raises the prices of the financial assets bought, which lowers their yield (Elliott, 2009).
US Federal Reserve Tapering
The Fed has started to scale back its massive economic stimulus program as the US economy belatedly recovers from the global financial crisis. The tapering has helped the US dollar rally but has caused outflows of capital in emerging markets, causing their currencies to fall dramatically.
FxPro chief economist Simon Smith said the Fed's tapering is bad news for developing economies (AAP, 2014).
"As the Fed embarks on tapering the pace of its bond purchases, which was at least initially strengthening the dollar and putting pressure downward pressure on the more vulnerable emerging market currencies," he said.
G20 members Mexico and Brazil, as well as G20 outsiders Indonesia and South Africa, have called on the US to provide more clarity on its wind-back and better communication to subdue the impacts on emerging markets (AAP, 2014).
Treasurer Joe Hockey told a G20 media briefing on Saturday morning that the world's central banks needed to co-ordinate their actions to avoid shocks to financial markets.
"I think if there is a `no surprises' policy in relation to monetary policy activity and central banks around the world have reasonable warnings of what may be events that do create market volatility then I think that's not unreasonable," he said at the G20 finance ministers and central bank governors' meeting in Sydney.
University of NSW economics professor Tim Harcourt said the G20's increasing importance meant much larger countries like the US were held accountable for the international impact of their policies (AAP, 2014).
"It gives some new economic stars like Australia, Brazil and South Korea a major say, which is a big boost for Australia," he said. "The G20 has taken the place of the G7 thanks to a big push from Australia which wanted a wider world stage and to change the hegemony of US-centric talks.
"The G20 will be looking at taking a broader role in working with the IMF (International Monetary Fund) to ensure economic stability." This is to avoid a worst case scenario whereby trade protection and unfettered capital flows weaken domestic financial institutions, which could have catastrophic consequences.” The Fed had been purchasing $US85 billion of government bonds from commercial banks each month in order to encourage lending and stimulate growth.
That has now been scaled back to $US65 billion a month and the members of the Fed's policy-making committee have expressed a desire to keep tapering as long as the US economy continues to improve.
Criticisms
India, South Africa, China and others have taken aim at the US Fed for its “tapering” program as they blame it for huge swings in their exchange rates and investment flows.
Indian central bank governor Raghuram Rajan recently renewed his criticism, saying the US needed to pay more attention to the concerns of emerging economies (Dagge, 2014).“I don’t think we can proceed forward saying everybody is in their own boat and they sink or swim alone,” he said.
India, Indonesia, Turkey and South Africa have had to raise interest rates to stabilize their currencies and rein in inflation.
US dollars flowed into frontier economies under the Fed’s quantitative easing program and moves to wind it back have caused huge amounts of cash to be pulled out.



Fundamental Criticisms
Transparency
One critique is that the Federal Open Market Committee, which is part of the Federal Reserve System, lacks transparency and is not sufficiently audited (Poole, July 2002). A report by Bloomberg News asserts that the majority of Americans believes that the System should be held more accountable or that it should be abolished.[31] Another critique is the contention that the public should have a right to know what goes on in the Federal Open Market Committee (FOMC) meetings (Roger W. Ferguson, April 19, 2001).
Economist Milton Friedman had concerns "about the stifled nature of the debate" over economic policy. He wrote to a colleague that ".....having something like 500 economists is extremely unhealthy. As you say, it is not conducive to independent, objective research. You and I know there has been censorship of the material published. Equally important, the location of the economists in the Federal Reserve has had a significant influence on the kind of research they do, biasing that research toward noncontroversial technical papers on method as opposed to substantive papers on policy and results (Poole, July 2002).
Monetary Policy
In the 2009 book The Road Ahead for the Fed, Carnegie Mellon's Allan Meltzer writes that, judging by the Taylor's rule guidelines on setting interest rates, former chairman Alan Greenspan's Fed policy was too expansive, considering that short-term interest rates remained negative as the economy continued to grow. Greenspan attributed this policy to his belief that the U.S. economy faced a risk of deflation (a decline in prices due to a tightening supply of credit) similar to Japan's experience in the 1990s.
Quantitative Easing
Some of the fiercest criticism of the Fed came after its November 2010 announcement that itwould buy $600 billion in long-term Treasury bonds to stimulate a struggling economy. The Fed hoped that this second round of so-called quantitative easing, or QE2—the first was implemented at the end of 2008 during the height of the crisis—would lower long-term interest rates, increase investment, and boost job growth. Twenty-three conservative economists wrote a letter to the Fed criticizing the plan for potentially stoking inflationary pressures, weakening the dollar, and failing to alter the jobless rate. QE2 wrapped up in June 2011. But following the S&P downgrade of U.S. debt in early August 2011, subsequent global market volatility, and fears of another recession, many investors have looked to the Fed to implement a third round of bond buying in the absence of any coherent fiscal policy by legislators, and indeed, it launched a new, open-ended quantitative easing program in September 2012 (Christopher Alessi, 2013).
The concept behind quantitative easing is to create more resources for the financial system, making banks freer to lend and the public more apt to borrow, says NYU's Cooley. Traditional tools used by the Fed such as open market operations and changing the discount rate or reserve requirements were no longer effective when interest rates hovered around zero, so for the QE programs, the Fed creates money at no cost and uses the funding to buy Treasury bills and mortgage-backed securities.

Many economists were concerned that credit will remain tight as long as there isn't enough demand to borrow. The Fed should continue to hold interest rates down, Cooley says, but additional rounds of QE won't help the economy: "Monetary policy can't solve economic problems." Nor, he says, reflecting the view of a number of economists, can it facilitate innovation or generate growth.
Despite the success of quantitative easing, most economists and Fed officials agree that the measure doesn't provide the fiscal, structural, and financial sector reform necessary for macroeconomic stability, and should therefore be rolled back once economic growth is sustainable. The Fed will begin "tapering" its bond-buying program in 2014, a move that will over the course of many years, pare down the Fed's balance sheet to pre-recession levels. That process is also expected to be controversial because as interest rates rise, the value of the bonds owned by the Fed will fall, resulting in unrealized losses if the Fed sells those assets before maturity. The IMF predicts that losses from the exit of these bonds could be as high as 4 percent of GDP.
Implications
The challenges to Emerging Market Growth have increased since May last year, when the US Federal Reserve signaled it would be reversing its easy money policy. Money, which had poured into emerging markets, started to flow out, sending currencies crashing and stalling economic growth (Hazelhurst, 2014).
The tapering process started last month when the Fed cut its $85 billion monthly quantitative easing (QE) bond buying programme by $10bn. It cut a further $10bn this month and the tapering is expected to continue through the year.
As capital flight constrains domestic expansion, the potential for collecting tax revenue reduces.
Solutions
Chinese finance minister Lou Jiwei had told the recent G20 finance minister’s meeting that structural reform in China had created 13 million jobs in the past year. Mr Lou criticised the US for relying on the monetary stimulus rather than undertaking structural reform in its own economy even as it called for more reform in China (Crowe, 2014).
“Take the U.S. for example: Its recovery is being helped by monetary policy and not much by structural adjustment,” “They have always been saying that China should boost its consumption ratio and the U.S. should boost its investment ratio, but that structural change is not happening in the United States.”
All countries have to be prepared to make difficult changes to their economies to boost global growth.



Altering Debt Structure
Based on research by economist Eric Swanson reassessing the effectiveness of the US Federal Open Market Committee action in 1961 known as Operation Twist, The Economist has posited that a similar restructuring of the supply of different types of debt would have an effect equal to that of QE. Such action would allow finance ministries (e.g. the US Department of the Treasury) a role in the process now reserved for central banks (Economist, 31 March 2011).

“It’s sort of the dawning of the reality that wherever it is the case in this environment, structural reform is going to be necessary (Crowe, 2014).
“If we want to have not just job creation but job security, we all have an obligation to undertake structural reform.”
Conclusion

We can no longer live in a world in which the US Federal Reserve is not held responsible for the result as of its actions. The world’s largest economy the US doesn’t hold its central bank to high regulatory standards that should not filter to the rest of the world out of negligence. A short story will put this in perspective.
There once was a ship the size of the Titanic sailing on the Atlantic Ocean. Their captain sailed into a stormy area, stopped using his compass and navigated by head. Beside it were a few smaller ships and a couple canoes. The titanic happened to have an accident in which it crashed with a big iceberg. In the midst of these accident boulders of ice fell on to the Titanic, tilting it from side to side and making it lose it balance. It was about to tip over till the captain decided to start throwing these blocks of ice into the ocean. The boats beside the Titanic would grab the blocks of ice , break them and use them for their various needs. It reached a point at which these blocks of ice actually helped the boats balance. These blocks of ice were pure water compared to sea water.
This is what transpired, after a while the ship regained balance and the captain wanted fresh water to drink (note you can’t drink sea water). He ordered his first mates to recall the ice blocks of water to the titanic. The first mates obliged. In doing so they began to tip the boats off balance, the boats in reaction threw some blocks into the ocean. Some of these blocks altered the waves and affected the canoes beside them.
In this story the Titanic is the US Economy, the boast are emerging markets (Nigeria, Turkey, India and South Africa and the ice blocks are capital inflows which the US Economy virtually calls back by cutting down QE (Quantitative Easing). The waves affect emerging markets in the periphery like Zambia.
This story goes to show that the actions of the US Federal reserve have been and will be global. They have to be regulated and governed as such. The US Federal reserve has to provide clear guidance on its QE program so as not to catch central bank around the world off guard forcing them to raise interest rate s
The US Federal reserve must also inevitably raise interest rates to make their monetary policy more effective. They cannot continually use QE as its only expansionary monetary policy tool. It places constraints on their effectiveness and spills over to emerging markets negatively.
The US Federal reserve must seriously look at restructuring their debt as an alternative to QE. There is also a great need to release some pressure of the Federal Reserve but reducing its mandate. You can’t have the Federal Reserve making inflation targets, unemployment targets, and monetary policy targets as well as stabilizing the economy. These targets prove counterproductive. The US government has to take some of the responsibility and conduct structural reform in the labour market as well as other critical areas.



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References
Bank of England . (2013, May 27 ). "Quantitative easing – injecting money into the economy". Bank of England .
BBC . (2013, March 6 ). "What is quantitative easing?". Retrieved from BBC : www. bbc.co.uk.
European Central Bank. (2008). The implementation of monetary policy in the euro area. . European Central Bank, pp. pp. 14–19.
AAP. (2014, February 22). Yellen to face tapering criticism at G20. Retrieved February 27, 2014, from http://www.sbs.com.au/: http://www.sbs.com.au/news/article/2014/02/22/yellen-face-tapering-criticism-g20
Bank of England . ( 2011, November 18 ). Learning the Lessons from QE and Other Unconventional Monetary Policies. Publications| Bank of England , pp. 17–18 .
Bernanke, B. ( 2009, January 13). "The Crisis and the Policy Response". Federal Reserve, p. Retrieved 4 April 2011.
Christopher Alessi, a. M. (2013, December 23). The Role of the U.S. Federal Reserve. Retrieved February 28, 2014, from CFR: http://www.cfr.org/international-finance/role-us-federal-reserve/p21020
Crowe, D. (2014, February 23 ). Joe Hockey backs US Federal Reserve on stimulus taper. Retrieved February 27, 2014, from The Australian: http://www.theaustralian.com.au/national-affairs/joe-hockey-backs-us-federal-reserve-on-stimulus-taper/story-fnll17p4-1226835120375#
Dagge, J. (2014, February 24). US Federal Reserve getting it right on tapering, says Joe Hockey. Retrieved February 27, 2014, from Herald Sun: http://www.heraldsun.com.au/business/us-federal-reserve-getting-it-right-on-tapering-says-joe-hockey/story-fni0dcne-1226835368924
Economist, T. (31 March 2011). Twisted thinking: Government Debt-Managers May be Undermining Quantitative Easing". In T. Economist, Twisted thinking: Government Debt-Managers May be Undermining Quantitative Easing". Twisted thinking: Government Debt-Managers May be Undermining Quantitative Easing". The Economist. 31 March 2011.
Elliott, L. (2009, January 8 ). "Guardian Business Glossary: Quantitative Easing". The Guardian (London), pp. ^ Elliott, Larry (8 January 2009). "Guardian Business Glossary: Quantitative Easing". The Guardian (London). Retrieved 19 January 2009.
Hazelhurst, E. (2014, February 26). Sound financial planning unbroken since 1994. Retrieved February 27, 2014, from IOL: http://www.iol.co.za/business/opinion/sound-financial-planning-unbroken-since-1994-1.1652699#.Uw7uqeOSxic
Poole, W. (July 2002). "Untold story of FOMC: Secrecy is exaggerated". St. Louis.: St. Louis Federal Reserve.
Roger W. Ferguson, J. (April 19, 2001). Transparency in Central Banking: Rationale and Recent Developments . Transparency in Central Banking: Rationale and Recent Developments.

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Emerging Markets Currency Depreciation :Case of Zambia by Kampamba Shula

Emerging Markets

The worst sell off in emerging-market currencies in five years is beginning to reveal the extent of the fallout from the Federal Reserve’s tapering of monetary stimulus, compounded by political and financial instability (Bloomberg, 2014).
The Turkish lira plunged to a record and South Africa’s rand fell yesterday to a level weaker than 11 per dollar for the first time since 2008. Argentine policy makers devalued the peso by reducing support in the foreign-exchange market, allowing the currency to drop the most in 12 years to an unprecedented low.
Investors are losing confidence in some of the biggest developing nations, extending the currency-market rout triggered last year when the Fed first signaled it would scale back stimulus (Bloomberg, 2014).
Two very troubling things:
1. uncertainty about the Fed policy,
2. Combined with concerns about growth, particularly in China. It’s difficult to justify that it’s time to go out and buy emerging markets at the moment
Investors don’t invest in emerging markets like they do in developed markets. Capital rushes in when the economy is hot; when the economy cools, investors dump their local currency holdings (Forbes, 2014). That leaves piles of devalued local currency which the central bank is hard-pressed to prop up. (In developed markets like the U.S., United Kingdom, Japan, in contrast, investors are more willing to hold on to the currency.)
In the midst of the Great Depression, President Franklin D. Roosevelt said, “We have nothing to fear but fear itself.” Fear of weakening emerging market economies – and the panicked reactions that follow – is a bigger driver of currency depreciation than the weakness itself. It is irrational exuberance in reverse (Forbes, 2014).
We’ve been seeing that phenomenon play out on the main stage for the past couple of weeks. The Argentine peso plummeted 15 percent in a single day (January 23rd); the “contagion” quickly spread to other emerging markets, including most prominently Turkey, South Africa, and Russia. It was what Bloomberg has dubbed “the single biggest sell off in emerging market currencies since 2009.”

Argentina – In January, the Argentine peso fell 23percent. The most dramatic peso depreciation since the country’s 2002 financial crisis was triggered by the central bank’s decision to stop intervening in the markets to maintain the peso’s value – intervention that was increasingly costly, draining the country’s foreign currency reserves (Forbes, 2014).
Turkey – The Turkish lira fell 6 percent in January; at its low point, the lira was down 9 percent from January 1st. On January 28th, the Turkish central bank took action to brace the falling lira, raising its benchmark one-week lending rate for banks from 4.5 percent to 10 percent. The lira rallied, then gave up those gains, and then recovered slightly (Forbes, 2014).
South Africa – The South African rand fell 7.5 percent in January, its weakest level since 2008. The currency continued to fall even after the central bank raised its benchmark interest rate to 5.5 percent from 5.0 percent – the first rate increase in almost six years (Forbes, 2014).
Russia – In January, the Russian ruble fell 7 percent, hitting a five-year low. But unlike the central banks in Turkey and South Africa, which have raised interest rates in attempts to prop up their currencies, Russia’s central bank has maintained a hands-off approach (Forbes, 2014).
What is causing the panic?
A confluence of factors is causing the emerging market panic. The first is the pull-back of stimulus in the U.S. Since September 2012, the Federal Reserve has pumped massive amounts of liquidity ($85 billion at its highest) every month into the global market in what has come to be known as “quantitative easing.” In December 2013, outgoing Fed Chairman Ben Bernanke announced the beginning of tapering – a $10 billion reduction in monthly bond buying. On January 29th, the Fed announced that it would reduce its bond buying an additional $10 billion, to $65 billion a month.
Much of the capital that the Fed was infusing into the market through its bond buying flowed to emerging markets. With the Fed tapering off quantitative easing, that liquidity is drying up. In simple terms, no more easy money. And that means that growth in emerging markets will, in all likelihood, be both more expensive, and slower (Forbes, 2014).
Both the tapering of stimulus in the U.S. and weakening of emerging market economies lead to currency volatility (clearly), which leads to panic, which leads to more volatility.
Emerging markets don't have enough foreign-money debt this time around to make their falling currencies much of a concern. What is a concern is whether their central bankers realize this. They might overreact—they might already be—and raise rates to prop up their currencies, when they should be lowering them to prop up their economies.

Zambia

THE Kwacha recently hit a historical-low against the United States dollar for the first time after the 2008-09 global financial crisis, as the foreign exchange market continued to witness low greenback supply
Similarly, Standard Chartered Bank says increased demand for the dollar resulted in the weakening of the Kwacha“
There is a sizeable mismatch between demand streaming mainly from local corporates and real money market players as compared to the current level of supply for the dollar which is likely to see the currency remain under pressure for the time being,” the bank says in its daily brief (Daily Mail, 2014).
The annual rate of inflation, as measured by the all items Consumer Price Index (CPI) for January 2014 was recorded at 7.3 percent compared to the 7.1 percent recorded in December 2013. This means that on average, prices increased by 7.3 percent between January 2013 and January 2014 (CSO, 2014)
Export Market Shares, December and November 2013
The Southern African Development Community (SADC) was the largest market for Zambia’s total exports, accounting for 32.6 percent in December 2013. Within SADC, Congo DR was the dominant market with 47.3 percent. Other notable markets in SADC were Zimbabwe, South Africa, Namibia and Tanzania.
Asia regional grouping was the second largest market for Zambia’s total exports, accounting for 27.2 percent in December 2013. Within Asia, China was the dominant market with 80.3 percent. Other notable markets in Asia were United Arab Emirates, Japan, India and Singapore.
Import Market Shares
The major source of Zambia’s imports in December 2013 was South Africa, accounting for 38.1 percent. The major import products from South Africa were Machines, structures and parts of structures, of iron or steel, contributing 9.4 percent.

Conclusion
South Africa has experienced the effects of emerging market contagion like other emerging markets. South Africa is Zambia’s biggest source of Imports. Dollar flows between the two countries are highly correlated. The supply of Dollars has been low due to investors pulling their money out of emerging markets on speculation about US Fed QE. This will continue to have ripple effects on the economies of emerging markets and the periphery. Zambia does not exactly qualify as a leading emerging market but is in the emerging market periphery.
There is a fundamental level at which the Kwacha should be trading and Bank of Zambia has figure which it uses to calculate this. The problem is that the emerging market currency volatility has created a contagion which had affected the supply of Dollars across the emerging markets and the periphery. This has resulted in a shortage of supply of Dollars in Zambia causing the sharp depreciation we have witnessed.

Recommendation
The Bank of Zambia faces a dilemma.
They could raise rates and get a foreign credit boom, or cut rates and have a domestic credit boom. If the central bank keep, or raise, rates high where they "should" be, it will only attract more "hot money"—quick, speculative capital looking for the best return—from abroad. This will make exports even less competitive by pushing up their currencies more, and set off a lending boom that could reverse itself at the click of a mouse.
But it is a bit of a catch-22. If the central banks keep rates lower than they should be, it will make the economy less attractive to yield-hungry foreign investors. Less capital will flow in, and exports will not be as priced out by a too-high currency—but persistently too-low rates will risk inflation and a credit boom of their own making.
I suggest Bank of Zambia wait it out and if any action should be taken I suggest doing the opposite of logical thinking and actually drop rates to support the local economy. Inflation may be a problem but the robustness of Zambia’s economy to withstand emerging market periphery shocks will improve.

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References
Bloomberg. (2014, January 24). Contagion Spreads in Emerging Markets as Crises Grow. Retrieved February 20, 2014, from Bloomberg: http://www.bloomberg.com/news/2014-01-24/contagion-spreads-in-emerging-markets-as-crises-grow.html
CSO. (2014, January 31). Bulletin January. CSO Bulletin, pp. 2-19.
Daily Mail. (2014, February 17). Kwacha hits histotic low against US dollar. Retrieved February 20, 2014, from Daily Mail: http://daily-mail.co.zm/blog/2014/02/17/kwacha-hits-histotic-low-against-us-dollar/
Forbes. (2014, February 3). Why Panic-Prone Emerging Markets Are Breaking Down In 2014. Retrieved February 20, 2014, from Forbes : http://www.forbes.com/sites/steveschaefer/2014/02/03/why-panic-prone-emerging-markets-are-breaking-down-in-2014/

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