The Federal Reserve's mandate does not require it to consider the foreign policy implications of its actions. But there is no doubt that the resumption Wednesday of quantitative easing--the printing of money to buy bonds and drive down borrowing costs--will have consequences for U.S. diplomacy. These will not be good.
For much of the past decade, the United States has urged China to stop managing the value of its exchange rate, arguing that capital markets function best when they are free of large government distortions. Before his elevation to the position of Fed Chairman, Ben Bernanke spoke out about a "savings glut." Surplus savings from emerging economies, partly a consequence of China's intervention in currency markets, were flooding the world with capital, creating the conditions for a bubble.
Today the argument for China to adjust its policies is more urgent than ever. As the world's largest high-saving economy, China is in a position to boost its consumption, supplying some of the stimulus that is so desperately needed in the United States, Japan, and Europe. But American complaints about self-serving Chinese policy will now look hypocritical. The Fed's return to quantitative easing threatens to create a glut of liquidity reminiscent of the mid-2000s savings glut. It is likely to inflate bubbles, notably in the fast-growing emerging world.
As well as harming the U.S. ability to take the high ground with China, quantitative easing will test the world's commitment to an open international economy. Already, countries from Brazil to Thailand have responded to the flood of incoming capital by imposing controls and taxes, retreating from the idea of financial globalization. To make capital controls stick, these countries may find they need to intervene heavily, policing the activities of multinational companies that are suspected of funneling capital illicitly between subsidiaries. Likewise, the new capital controllers may demand the right to police trade invoices, since over- or under-invoicing is a time-honored method for circumventing capital controls.
None of this might matter if next week's G20 summit were on track to succeed wonderfully. But the Fed's super-loose policy is straining the international monetary order at a time when the spirit of international cooperation looks particularly limp. Across the rich world, leaders have been weakened by a sluggish economy that has dragged down their poll ratings, undercutting their appetite for ceding unpopular concessions to foreigners.
In the two years since the low point of the global financial crisis, the international economic system has held together better than might have been predicted. There has been no surge of protectionism, and for a while all the major economies were in agreement on the need to stimulate. But it would be rash to assume that this pattern will persist indefinitely. Even before the Fed's action this week, there was much loud talk of currency war. This now seems sure to intensify, and the United States has lost its moral authority to broker currency peace.