Quantitative easing must make the dollar fall and assets like gold rise, conventional wisdom has it, because the printing of all of the dollars that the Federal Reserve is using to buy Treasury bonds - the Fed's balance sheet has nearly tripled since the end of 2007 to about $2.5 trillion - should dilute the currency's value. There's just one problem with that analysis: The dollar is roughly where it was back then - actually about 3 percent higher - despite the massive expansion of the Fed's balance sheet.
OusmÃ¨ne Mandeng, head of public sector investment advisory at Ashmore Investment Management, a leading manager of emerging market debt portfolios, offers a commonsense, yet apparently uncommon, explanation for the dollar's resilience. While most investors and economists are concentrating on the ballooning number of dollars that the Fed is spreading around, he reasons, they are ignoring the other side of the ledger - the Treasury bonds that the central bank is buying and holding. "Most of that additional supply has remained on the Fed's balance sheet in the form of non-borrowed reserves," Mandeng points out in a note to investors.
Perhaps more important, they are ignoring a key intangible - the support that quantitative easing provides for U.S. stock and bond markets and the dollar by attracting fresh capital from investors who think that the Fed is on their side. Here's what Mandeng says on that score: "Some emerging markets policymakers and others have been protesting repeatedly that the U.S. Federal Reserve's policy of quantitative easing (QE) - or credit easing - causes a weaker dollar and channels unwanted hot money flows into emerging markets. Actually, the opposite may be true. On the one hand, issuance of dollar liquidity due to substantial securities purchases by the Fed should weaken the dollar, all else being equal. On the other hand, the explicit price support provided by the security purchases should support the dollar. Whatever effect dominates will determine to a large extent the dollar's external value. The limited monetary expansion to date suggests that the effect of securities purchases is likely to dominate. Hence, QE seems dollar supportive."
Mandeng points out that the main broad measure of the American money supply grew by 2.5 percent in the 12 months through January, well below the 6.5 percent annual rate of the preceding decade. That shrinkage also supports the dollar.
His analysis is a bit wonky for the average investor; he used to work for the International Monetary Fund, where wonkiness is a basic job requirement. What it all means is that investors who have been dissing the dollar for years may be in for some disappointment.
Gold fetishists have fared much better - the metal has been hitting all-time highs - but one of their main reasons for owning it is that it's the undollar. Once it becomes clear that quantitative easing is not killing the dollar, the true believers in gold may begin to have second thoughts. The fact that gold has underperformed many other commodities for several months suggests that it's happening already.