Raghuram Rajan, the head of the Reserve Bank of India, stated earlier this year at the Brookings Institution that “some advanced economy central bankers have privately expressed their worry that the QE ‘works’ primarily by altering exchange rates…” In other words, without the effect that QE has on exchange rates—lower for the U.S. dollar—there may not be much of an effect at all. It is also likely that the highly accommodative Fed policy resulted in a dollar that was weaker than it otherwise would have been—and this may be the main mechanism through which QE is transmitted to the markets. The depreciating dollar leads to commodities that are more expensive in dollar terms. Rajan was making a claim that is a far more significant admission than it initially appears.

This means that not only was China buying far too much in the way of commodities, but the U.S. was spurring additional demand and propping up prices as well. And this is a boost to the U.S. economy. Higher oil prices make more U.S. shale production possible and therefore allow more hiring in the oil sector along with causing more marginal projects to be profitable. To illustrate how critical oil is now to the U.S. economy, 32 percent of GDP growth in the United States occurred in Texas between 2007 and 2013. Since 2008, Texas has also created more jobs than the rest of the country. And these jobs matter. Many jobs in oil patch require the presence of the worker and cannot be done without a significant amount of education. These characteristics make them difficult to offshore or relocate—many of the oil field jobs are uncontestable. As quantitative easing begins to roll-off, the ability of the U.S. shale revolution to stand on its own will be tested, and the jobs engine of Texas may suffer. This would be a tremendous hit to a sector where wage pressures exist, and the contestability is low.

The Fed should be watching this closely. The United States is actually reliant on oil for a significant portion of its own growth, and sustained lower prices could spell trouble for the only bright spot in the U.S. economy. Without realizing it, the Fed has been fighting a trade war. At any rate, it is becoming increasingly evident that unconventional monetary policy creates outcomes far beyond those that are intended.

The Weakest Link

Simply stated, there is far too much leverage remaining in the systems of countries who received the benefits of both the U.S. and China bubbles. Commodities are the weakest link between the two stimuli—both the U.S. and China pumped them and the dual taper threatens to pop the commodity bubble. Each country used a unique mechanism of intervening to spur growth, but ultimately affected the commodity markets by pushing prices and volumes above a globally sustainable level. How will the world react when there is nothing propping it up? It is likely it will be too late to make better capital allocations and much of the capital spending—tied to marginal commodity extraction—will become the transmission mechanism of the next big bubble. Households never corrected in much of the emerging world during the Great Recession, because there was no reason to do so. The U.S. can ill afford to lose its uncontestable jobs for the third time in a little over a decade. But all it takes is a slowdown, a slight step back from China and lack QE or ultra-low rates from the Fed and the commodities come crashing down. The question is how much of the world goes with them. And without the dual stimulus, it could be most of it.

Samuel Rines is an economist with Chilton Capital Management in Houston, TX. Follow him on Twitter @samuelrines.

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