Beware the sizzle, at least until you taste the quality of the steak.
First reactions from the equity market to the Federal Reserve's additional wodge of $600bn of qualitative – sorry, quantitative – easing have been positive. Shares in the US rose a couple of percentage points, the UK more, and this, coming on top of earlier rises in anticipation of these measures, means that they have now clambered back the ground lost following the collapse of Lehman Brothers. The FTSE 100 index is back to the level of June 2008.
But the move has been met with a barrage of criticism from the authorities in two of the main emerging economies, China and Brazil, and has also led to concern in the eurozone's largest and currently most successful economy, Germany. More directly, while the interest rate on US 10-year Treasury bonds fell, the rate on very long-term ones actually rose. So the market vote in favour of the initiative was not unanimous.
So there are two quite different views. One is that the Fed is doing what has to be done to keep demand moving at a time when the economy has been staging a slow and near-jobless recovery – indeed some people argue it should be doing even more. The other is that it is printing money so that the US government can continue with its huge budget deficit, the largest ever in peacetime, and it is trying inflate away the real value of the country's debts. Which is more likely to be proved to be right?
Step back a moment and see this in context. As you can see from the chart, the initial bout of QE, not just in America but also in Europe, the UK, Japan and so on, halted the collapse of asset prices worldwide. It does not matter whether you look at equities, commodities, corporate bonds, emerging market sovereign bonds – the whole lot had tumbled down and, pretty much coincidentally with the advent of the first bouts of QE, turned about and established a steady climb. It was an exceptional policy for exceptional times and it worked.
The arguments now are different. This is not a co-ordinated international policy. The European Central Bank is not going to follow suit, and the case for the Bank of England doing so is weak. This is US policy designed to cope with a problem that seems to be even greater in the US than elsewhere: debt-laden consumers, a housing market that is still extremely weak, and a budget deficit that has not yet been brought under control. And America seems to be able to get away with it because the dollar is a reserve currency. From the perspective of the US, this is to get the economy moving. From the perspective of much of the emerging world, it is to make US exports more competitive at the cost of their own.
That point, that this may be helpful to the US but the effect is to export the country's problems to the rest of the world, has been made by both the Chinese and the Brazilians. China is in a corner, because it links its currency to the dollar and has resisted pressure to revalue it, or at least to revalue it by very much. Brazil has a new government and will assert itself to stop its currency rising further, maybe by bringing in capital controls. Other emerging nations are apparently preparing controls too.
We'll see. I don't think it makes a lot of sense to declare currency war. The president of the ECB, Jean-Claude Trichet, said that he did not think that the US was deliberately trying to devalue the dollar, and that is surely the right response. This move may be seen as a trigger for a wider rethink in the developing world about the role of the dollar, but there is no point in speculating about that now.
The more immediate concerns are that the policy is risky and may be ineffective. I was in the US last week and, frankly, everyone was so preoccupied with American politics and the sense of economic distress that there did not seem to be much space of mind left over to ponder the global implications of policy. Here in London there may be more perspective. For example, Ted Scott at F&C Investments (who created the graph) makes the point that without supply or demand for credit the Fed cannot push the money it has created into the economy. Meanwhile, it is creating dangerous asset bubbles and if it carries on, he argues, it is in danger of debasing the currency and generating inflation.
Further scepticism comes from Michael Dicks at Barclays Wealth. His analysis of the evidence is that this new bout of QE should add a bit to GDP growth, but this would not be huge. He makes the point that the danger now is that any boost from marginally lower long-term rates, higher share prices and a lower exchange rate, might be more than offset by international resistance. He writes: "Any potential benefit flowing through to global growth from increased confidence, stemming from the recent rise in equity markets, could easily be lost – or more than fully offset even – by "bombs going off", in the sense of new policy shifts and disagreements between policymakers that rupture the new sense of progress towards a stronger global economy."
We will have to see how this plays out in the coming weeks. I think it is pretty clear that this is the end of the line for QE both in the US and the rest of the world. Yes, if there were some further economic disaster then maybe it could be revived. But three points stand against it. One is that the risk/reward ratio has tilted against it. Yes, it may help boost demand a bit but the risks of an adverse market reaction, were it seen to lead to greater inflation, may offset that. The second is that global opposition is mounting and it is the rest of the world that has been supplying the main increment to world demand through the downturn. And the third is that the US may be stoking up the next asset bubble, and we should all be worried about that.
The G20 moves to Asia, but fights over the US dollar will take centre stage
Tensions over US economic policy will have a focal point this week in Seoul, South Korea, at the Group of Twenty summit meeting. You may recall that the G20 has, in theory at least, taken over from the G7 as the main body co-ordinating world economic policy – reflecting the shift of power from the old developed world to the new emerging one. This will be the first time a summit is hosted by a G20 member which was not also a G7 country.
There will be two broad themes. One will be the whole business of current account imbalances, the extent to which the US is trying to cut its deficit (and boost demand) by pushing down the dollar and so on. The issue is whether you should have explicit targets for current accounts, the idea being that countries which run up huge surpluses will have a responsibility to get them down. The US would like something like this but, as you might imagine, it is not something that most of the Asian "tigers", which have built their economies on exports, would be thrilled about. If the basic point gets established that trade has to benefit both parties that would be a start, but low expectations would be prudent.
The other theme to be pushed by the Korean hosts might make more progress. It is that Western aid policy should shift away from financial handouts towards greater trade access and investment in infrastructure. The "trade not aid" case has been made many times, but three things have changed that give this legs. One is that this it is coming from an Asian country, albeit a highly developed one. The second is that Chinese investment in infrastructure in Africa is much larger than all Western aid programmes put together – real trade not aid. And third, there is huge pressure on Western aid budgets, and not all countries may be as protective of those budgets as the UK seems to be. So maybe, just maybe, this is an idea whose time has at last come.Reuse content