Graham Turner makes a seemingly compelling case for the Federal Reserve to have gone in for quantitative easing in its meeting last week ("The Fed has not avoided danger", June 30). However, he fails to persuade.
First, there is no empirical record in favour of quantitative easing. It is hard to make a case based on precedence. Second, the need for it in the US seems dubious, at best. In Japan, the rise in base money growth did not translate into a rise in bank credit because the credit transmission mechanism was (and is) impaired. In the US, banks have thrown money at consumers for housing and corporations have raised more than $96bn in the first half of the year in junk bonds - more than the full sum raised last year. Is credit availability a problem? Does it indicate an economy that is exactly demand-deficient?
Lack of demand deficiency is also indicated in the sizeable and rising current account deficits. In the case of Asia, post-crisis, imports collapsed and countries quickly posted large current account surpluses indicating pervasive weak demand. Such is not the case with the US.
Its current account deficit has continued to grow throughout the past three years. Fiscal policy has swung from a surplus of 1.5 per cent of gross domestic product to a deficit of more than 4.5 per cent of GDP. Short-term interest rates are down by 550 basis points. At one level, the surprise should be not that bond yields have gone up in the past fortnight but that it took so long for them to do so.
Given this backdrop, the putative advantages of quantitative easing should be seen against its costs. It may not work, given that the Fed stopped reporting targets for money supply growth in 2000 citing their weak links to real economic activity.
In that case, excess liquidity would find its way into financial assets creating another bubble within three years of the last one. It would keep alive companies that should have folded, through the availability of easy credit. Advice of "tough love" is easy to dole out to others but hard to practise at home.
If it works too well on the real side, the bond yields have a lot of ground to cover. Consumers would be adding to their debt even as bond yields begin to rise, setting the stage for a real debt implosion and deflation when the next economic shock along. Foreigners hold nearly a third of all outstanding Treasuries at the end of Q1 2003 (nearly $1,300bn). If they are scared by rising yields and begin to dump, the US dollar will not experience an orderly correction that the Federal Reserve and the Treasury have implicitly sanctioned. It will be chaotic. Other countries would be forced to cheapen their currencies to resist importing deflation from the US.
Source: V. Anantha-Nageswaran, Financial Times
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Friday, July 04, 2003
Springing the Trap?
Posted by Edward Hugh at 12:11 PM