Summary: Historians will laugh at our response to QE, for the reasons discussed here. We’re enjoying our days in Wonderland. We may find the hangover less entertaining. This is a follow-up to Important things to know about QE2 (forewarned is forearmed). Links to more information appear at the end.
Our response to the Federal Reserve’s latest monetary stimulus — QE2 — makes sense only in Wonderland. Few economists believe it will have substantial economic impact — $600 billion over 9 months is a dot to the US economy, and a microdot to the global economy. Even fewer expect a positive impact. It’s a desperate act, a hail Mary pass to prevent the looming deflation. Our response has been defening applause, with a minority booing. Both groups’ views are firmly rooted in complacency. A more appropriate reaction would be concern. Or fear.
Three likely (but not certain) effects of QE2:
- a slight decrease in medium-term interest rates;
- rising prices for stocks, bonds, commodities, and real estate;
- a falling US dollar.
(1) The effect of the tiny decrease in rates is likely trivial. Short rates are unaffected; long rates might even rise.
(2) Boosting asset prices, raising spirits of the 20% of Americans who own 85% of its wealth. The direct effect on the other 80% will be nil, as they own little except their homes (7% of total US wealth ex-homes). With 19 million vacant homes (14%), even the God-like Fed cannot boost home prices. QE2 attempts to create prosperity by blowing bubbles. It never works. It cannot work. The danger is real, but this attempted solution is insane. Only incompetent leaders would allow this. Only a population of fools would applaud.
(3) Depressing the value of the US dollar. This will slowly boost exports and increase the cost of imports, with a small net stimulus to the US economy. And large disruptive impacts on the global economy, as the Fed’s newly printed money floods the emerging nations. Most have current account surpluses, and don’t need our money. Yet the money floods in, pushing up their currencies and asset prices — disrupting their trade and domestic economies. Worse, any nation can engineer a drop in its currency. Stopping the decline can be more difficult, especially once it drops below its all time lows (less than 10% away for the US dollar major currency index).
We are sheep, so the QE2 will run smoothly (if ineffectually) at home. We might have a recovery, in which case all will be well. Equally likely, the US economy might continue to slowly deteriorate (as it has since Spring 2010), the necessary deleveraging prevented by a combination of complacency, stagnant wages, and government stimulus. So household and corporate debt levels have declined only a few percent since their pre-recession peaks, while government debt has skyrocketed.
More interesting, and ultimately more important, will be decisions of the emerging nations’ governments. Our leaders assume these nations can only accept whatever we inflict on the world’s financial system. But in an interconnected world, even a global hegemon should consult with the other major nations before taking extreme measures that affect everybody. Which side is right? Since God will not say, we will never know.
It’s a match-up of the sort that sometimes changes history. A large decaying power against collectively larger and far faster growing nations, participants in a global regime they did not make and which they have outgrown. They have already begun to rebel. Brazil and Thailand have instituted taxes on foreign purchases of government bonds. More may copy them. And these might be just the first steps, with stronger measures to follow. Like capital controls, which were commonplace from WWII until the 1970’s.
Capital controls would end the post-WWII era. Nations with large capital account surpluses (e.g., China) would adjust with difficulty. Nations with large current account deficits, like us, would adjust less easily. The geopolitical order would change as well. For example, financing our foreign wars and world-encircling chain of bases would for the first time require sacrifices.
For more information
- “Did Quantitative Easing by the Bank of Japan ‘Work’?“, Economic Letter of the Federal Reserve Bank of San Francisco, 20 October 2010
- “Federal Reserve Rains Money On Corporate America — But Main Street Left High And Dry“, Shahien Nasiripour, Huffington Post, 3 November 2010
- “How Should Emerging Markets Manage Capital Inflows and Currency Appreciation?“, Nouriel Roubini, Roubini Global Economics, 4 November 2010 — Subscription Only.
Posts about solutions
- A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
- A solution to our financial crisis, 25 September 2008
- A quick guide to the “Emergency Economic Stabilization Act of 2008″, 29 September 2008
- The last opportunity for effective action before disaster strikes, 3 October 2008 — How to stabilize the financial system.
- Effective treatment for this crisis will come with “The Master Settlement of 2009″, 5 October 2008
- Dr. Bush, stabilize the economy – stat!, 7 October 2008
- The new President will need new solutions for the economic crisis, 9 October 2008
- New recommendations to solve our financial crisis (and I admit that I was wrong), 23 October 2008
- A look ahead to the end of this financial crisis, 30 October 2008
- Everything you need to know about government stimulus programs (read this – it’s about your money), 30 January 2009
- Bush’s bailout plan is now Obama’s. His quiet eloquence guides the sheep into the pen, 30 March 2009
- Cash for Clunkers is madness! Let’s expand it to new horizons!, 6 August 2009
- The falling US dollar – bane or boon?, 14 October 2009
- Government economic stimulus is financial heroin, 28 December 2009
- A lesson from the Weimar Republic about balancing the budget, 10 February 2010
- Why the U.S. cannot inflate its way out of debt, 16 March 2010
- We’re still blinded by our fetters of the mind and so unable to fix the economic crisis, 13 September 2010