Time to turn off printing presses
It is difficult to justify further rounds of quantitative easing now that an economic recovery is under way, writes Jeremy Warner.
ONLY a year to go now. Ben Bernanke, chairman of the US Federal Reserve, has let it be known that he will not be seeking a third term once his present one expires in January 2014, and few can blame him.
The last seven, crisis-ridden, years would already have finished off a lesser man. The poor chap must be exhausted.
It is perhaps still too early to be passing judgments on his reign, but on one level it certainly does not seem so bad, given the challenges faced. Bernanke has arguably done better than central bankers in Europe, Britain and Japan in terms of his crisis response.
One powerful contributor to recent US growth has been the "fracking" gas revolution, which is delivering cheap energy worth perhaps as much as 1 per cent of GDP a year to the US economy.
But there's no objective way of measuring the extent to which aggressive money printing by the Fed has contributed to the US turnaround. The general assumption, confirmed by a number of self-serving Federal Reserve working papers is that it must have done, since the US avoided a repeat of the Great Depression and now seems to be mending quite rapidly.
Whatever the truth, one thing is for sure. It is difficult to justify further rounds of money printing given the evident recovery that is now taking place. Even so, Bernanke has indicated he will keep the printing presses at full throttle at least until unemployment sinks below 6.5 per cent.
This is a mistake, with some possibly quite malign unintended consequences for both the US and world economies.
The initial burst of quantitative easing had wide-ranging support, both in the US and Britain, when it seemed a necessary tool for combating the collapse in the financial system and the accompanying, violent, contraction in credit.
And by targeting the "toxic" loans of failing banks for asset purchases, the Fed seems to have practised a rather more effective form of it than we saw in Britain and Europe.
In Britain, by contrast, quantitative easing has almost exclusively targeted government debt, which has been helpful to the government in helping to fund a still burgeoning fiscal deficit at very low interest rates - and in keeping the bankers in bonuses - but has failed to restore health to the banking system and seems increasingly ineffective in stimulating demand in the real economy.
Meanwhile, the European Central Bank largely spurned asset purchases altogether and instead focused on long-term liquidity facilities. Solvency issues in the European banking system have therefore remained substantially unaddressed, preventing meaningful economic recovery.
Even so, the injection of central bank liquidity seems to have done a relatively good job in preventing catastrophe. Whether quantitative easing can continue to be justified after the financial system has been stabilised is more questionable. The trouble is that today the purpose of quantitative easing is no longer really that of depressing interest rates or preventing a collapse in the money supply, but that of attempting to support aggregate demand.
Growing concern over mountainous public debt has left governments increasingly reliant on the supposed miracle remedies of monetary policy to restore economic growth.
Monetary policy has become the only game in town, so much so in Britain the government has elevated faith in the easy money policies of the Bank of England to cult-like status. Britain has blazed the trail, the Prime Minister once boasted, as "fiscal conservatives but monetary activists". Regrettably, and perhaps predictably, the cult of quantitative easing has failed to deliver the goods.
Of course, it is possible things might have been worse without it, but the longer it goes on, the less likely this seems, and meanwhile some quite counterproductive long-term consequences are starting to emerge.
Some of the wider adverse consequences of quantitative easing have been brilliantly elucidated in a paper for the Dallas Federal Reserve by William White, former economic adviser at the Bank for International Settlements.
Since White was one of the few monetary gurus to have accurately highlighted the dangers of the credit bubble when it was still possible to do something about it, his analysis deserves some attention. His main conclusion is that there are limits to what central banks can do, and that monetary stimulus has essentially already hit the buffers. The consequences of persisting are therefore quite likely to be negative.
These negatives include misallocation of capital likely to prove harmful to growth in the long run. For instance, easy money encourages banks to keep existing debtors afloat even though they might be insolvent, thus denying credit to new businesses and younger households. This "evergreening" of long-standing debtors creates weak customers.
What's more, quantitative easing results in some undesirable distributional effects. Those able to afford it are charged higher interest rates than otherwise, while debtors are constantly favoured over creditors.
The previously profligate are rewarded, and the thrifty are punished. Easy money in response to a crisis can also generate serial bubbles, with each action setting the stage for a later crisis.
Worst of all, it encourages governments to do nothing. One possible defence of quantitative easing is that it at least buys time for governments to engage in debt reduction and structural reform to redress imbalances and increase potential growth.
This time is not being well used. To the contrary, quantitative easing has become an excuse for doing nothing and carrying on as before in the hope something will turn up. By allowing governments to borrow more cheaply, it also positively encourages irresponsible spending.