As central bankers prepare for what has in effect become their annual conference in Jackson Hole, Wyoming this week global financial markets are anxiously awaiting word of the potential for another round of quantitative easing.
The likelihood of QE3 has been hotly debated in recent weeks and US Federal Reserve Chairman Ben Bernanke is likely to use his keynote speech at the symposium to signal his thinking. Unsurprisingly, markets are hopeful of another injection of cash into the global monetary system in the hope that asset prices, particularly equities, will receive a boost.
But another round of monetary easing is not a forgone conclusion and the supposed benefits are in dispute. Aside from the fact that cheap and easy credit, propping up unrealistic asset prices, is largely what got us into this mess in the first place, there is a growing awareness that central bankers and their money creation machines cannot solve the deeper underlying problems confronting the world's big economies. This critical insight recognises that the current global economic malaise has shifted from being a liquidity crisis to a crisis of politics.
Already the United States has near zero interest rates and a further round of quantitative easing cannot push those rates any lower. Furthermore, there is no guarantee that the major banks, through which the Federal Reserve conducts its open market activity, will make the new dollops of cash available to firms in the real economy. On this point the banks have form. During the GFC the US Fed provided over a trillion dollars (the Fed says $1.2 trillion while others such as Bloomberg claim seven times that amount) to major financial institutions who then held onto the funds to bolster their capital reserves rather than issuing loans and stimulating the real economy as the Fed had intended.
But even if the banks were prepared to extend new loans there is considerable doubt about whether anyone would put their hand up to take them and it this lack of demand that weakens the argument for a further round of easing.
Japan's experience over the last two decade provides a case in point. Following its stock and property market crash of 1991, which in itself was largely a result of cheap and easy money, the Bank of Japan flooded the economy with cash and pushed interest rates to near zero where they have remained for years.
But despite the plentiful supply of money at giveaway prices there were simply no takers. The problem was not the availability of credit or its price but rather demand. Deep structural problems within the Japanese economy and the absence of the political will to fix them dampened consumer demand and the corresponding requirement by business for funds to invest in future growth.
And just as politics has prevented Japan arising from its slumber so too it is politics that threatens the economic revival of the US and keeps the European Union on the brink of disaster.
In the US business is confronted with an ever expanding deficit and no plan to fix it in either the near or medium term. Furthermore, the economy is threatened with a deep fiscal contraction in the New Year if the President and Congress are unable to end a stand-off on measures to cut entitlements and close tax loopholes. Recognising these growing deficits as future tax claims on business earnings firms are unwilling to part with the cash they have hoarded and invest in employment generating growth.
None of these problems can be fixed by more cheap money. Instead American leaders, both Democrats and Republicans, need to find the requisite political will to address these fiscal issues.
In Europe the same political will is required. While government deficits must come down in southern Europe and a solution must be found to immediate liquidity and solvency crises this alone will not address the long-term issues confronting the Mediterranean Sunbelt. Each of these economies, particularly those of Italy and Spain, require significant structural reform in areas such as professional services and labour markets if they are to have any chance of regaining a degree of competitiveness. And just like in the US more cheap money is not the answer. Instead, politicians must summon the will to make the necessary reforms even in the face of hostile opposition from powerful special interests.
The global crisis, whether financial or economic, is now in its fifth year despite the best efforts of central bankers. The unprecedented printing of money and the extraordinary low interest rates in many economies have failed to fix the underlying problems. While more of the same may keep us going for a while longer there is no reason to believe that the long-term outcome will be any different to that, which has already occurred.
This signals that a global recovery needs more than central bankers can provide. Economic reform requires action from the world's elected leaders. Only they have the power and the electoral legitimacy to bring about the necessary changes. The global crisis has shifted from being one of liquidity or solvency and is instead a crisis of political will. In essence, the greatest risk confronting the global economy right now is political.
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