Central banks on both sides of the Atlantic took extraordinary monetary policy measures in September, but Republican policies would destroy any chance of America regaining it’s once-lofty status.
The long awaited “QE3” (the third dose of quantitative easing by the United States Federal Reserve), and the European Central Bank‘s announcement that it will purchase unlimited volumes of troubled eurozone members’ government bonds are the last weapons in their arsenals. Not surprisingly, markets responded euphorically, with stock prices in the US, for example, reaching post-recession highs.
Others, especially on the clueless (or diabolical) political right, worried that the latest monetary measures would fuel future inflation and encourage unrestrained government spending.
Both the critics’ fears and the optimists’ euphoria are uncalled-for. With so much underutilized productive capacity today, and with immediate economic prospects so dismal, the risk of serious inflation is non-existent.
Nevertheless, the Fed and ECB actions sent three messages that have shaken economists and should have given the markets pause:
- They were saying that previous actions have not worked.
- The Fed’s announcement that it will keep interest rates at extraordinarily low levels through to mid-2015 implies that it does not expect recovery anytime soon. That should cause immense worry for Europe. Their economy is far weaker than America’s.
- The Fed and the ECB were saying that markets will not quickly restore full employment on their own. A stimulus is needed. That should serve as a comeback to those in Europe and America who are calling for just the opposite: further austerity.
Republicans Hate to Hear This
The stimulus that is needed is a fiscal stimulus. Monetary policy has proven ineffective, and more of the same will not return the economy to sustainable growth. Austerity would plunge the U.S. into the same condition as Europe, regardless of the ill-informed conservatives and their mind-numbing refusal to simply look across the Atlantic to see what austerity is doing to the UK and the Eurozone .
In traditional economic models, increased liquidity at low interest rates results in more lending, mostly to investors and sometimes to consumers, thereby increasing demand, employment, and the upward spending spiral. But in cases like Spain, Greece, and coming for Italy, Portugal and Ireland, so much money has fled the banking system, that simply adding back liquidity, while continuing current austerity debt policies, will not reignite the Spanish economy. In fact, it will prolong it and make any conceivable recovery harder to achieve and slower.
In the US, smaller banks that are the primary financing source for small- and medium-sized enterprises have been idiotically disregarded. The federal government, under both George W Bush and Barack Obama, allocated hundreds of billions of dollars to prop up the mega-banks, while allowing hundreds of these crucially important smaller lenders to fail.
Sadly, it’s my opinion that lending would be subdued even if the banks were healthier. Small enterprises rely on collateral-based lending, and the value of real estate, the primary means of collateral, is still down one third from its pre-crisis level. Given the extent of the glut of capacity in real estate, lower interest rates have done, and will do little to revive real-estate prices, much less stimulate demand through increased consumption.
Continued Washington Gridlock Will Be Devastating
Marginal effects are still probable: minor changes in long-term interest rates resulting from QE3 could possibly lead to a little more investment; some of the rich will take advantage of temporarily higher stock prices to consume more; and a small number of homeowners will be able to refinance their mortgages, resulting in lower payments and allowing them to increase consumption.
But temporary measures result only in a fleeting blip in stock prices; scarcely enough to support spending splurges. Reports suggest that few of the benefits of lower long-term interest rates are filtering through to homeowners: but the major beneficiaries are the banks. Most homeowners who want to refinance their mortgages still cannot, because they are “underwater” (owing more on their mortgages than the underlying property is worth).
The US could also benefit from the exchange-rate weakening that follows from lower interest rates. The competitive devaluation however would come at the expense of America’s trading partners. But, given lower interest rates in Europe and the global slowdown, the gains are likely to be small even here.
Some economists worry that the new liquidity will lead to worse outcomes: a commodity boom, which would act like a tax on American and European consumers. People, who were cautious and held their money in government bonds, will see lower returns, further restricting their spending. And low interest rates will encourage firms that do invest to spend on fixed capital rather than labor-intensive business, thereby guaranteeing that, when recovery comes, it will be comparatively jobless.
There is a additional risk for Europe: if the ECB focuses too much on inflation, while the Fed tries to stimulate the US economy, the interest-rate gap will lead to a stronger euro, depressing Europe’s competitiveness and expansion projections.
Future Remains Murky
The real peril now is that politicians and markets actually believe that monetary policy can revive the economy. Regrettably, monetary policy’s effect at this point is to divert attention from measures that would truly stimulate growth.
The current downturn will not end anytime soon. In short, that is what the Fed and the ECB are saying. If we elect a new set of fiscal conservatives and make drastic spending cuts across governmental sectors, the few gains that we have made will quickly turn to dust. Continued gridlock will be a slower death.
Given the propensity for low-information trends among U.S. voters and the ruthlessness with which the Republicans operate and their newly unlimited finances due to a conservative, activist Supreme Court, Americans appear to be in for a turbulent future unless November 6th produces some surprising results.