In bringing an end to its quantitative easing, US Fed needs to ensure it does not create global financial instability

Two weeks after the "Bernanke shock", the stock and currency markets have returned to a close-to-normal state. On June 19, when Chairman of the US Federal Reserve, Ben Bernanke, gave a clear signal the Fed would gradually reduce and ultimately quit its quantitative easing, $340 billion evaporated in the world bond market, and world stock markets tumbled.

However, the top concern for emerging economies, including China, is the outflow of capital. According to EPFR Global, which tracks cross-border capital flows, after the Fed initiated its third round of quantitative easing in September 2012, roughly $90 billion flew to the stock markets of emerging economies during the 17 weeks between Sept 1, 2012 and Jan 2, 2013, compared to only $15.9 billion during the whole of 2011. However, the trend had started to reverse even before the Bernanke shock, with a net outflow of $5 billion from emerging economies in the week ended June 5.

The restrengthening of the US dollar may cause the emerging economies even more concern. The strong dollar from 1979 to 1985 contributed to the Latin America debt crisis in the 1980s. A strong dollar from 1995 to 2002 also contributed to the Asia financial crisis in 1997 and 1998, the Russian financial crisis in 1998, the Brazilian financial crisis in 1999 and the Argentine financial crisis in 2001. If the dollar appreciates by another 10 percent in the next 12 months, the leading emerging economies will face serious trouble.

The Fed's decision to quit its quantitative easing policy is undoubtedly necessary. Although quantitative easing measures have helped the US economy recover, they would have been harmful to the US and world economy in the long run. The basic function of quantitative easing is merely an expansion of liquidity and leverage, instead of supporting innovation and the real economy.

Quantitative easing would not support long-term substantive economic growth because the fundamental problem in the US economy is the lack of a strong, competitive and innovative real economy, rather than a monetary one. Quantitative easing would ultimately delay the necessary restructuring and innovation the US needs for robust, sustainable growth.