Easing should stop immediately

In: Uncategorized

8 Nov 2010

This is my latest Fund Strategy comment.

Quantitative easing (QE) should cease immediately on both sides of the Atlantic. In the short term it might cause a stockmarket crash, or even a double dip recession, but in the long term it could be the necessary step if the economic challenges facing the developed world are to be tackled.

QE has become an evasion from dealing with the chronic lack of productive investment in the West. There may be a case for printing money if an economy is suffering from short term liquidity problems. When faced with chronic economic weaknesses it only makes matters worse.

Although the technicalities of QE may be complex it essentially involves one arm of government (the central bank) buying bonds from another (the treasury). Such easing of credit conditions boosts demand temporarily. It cannot solve the fundamental problem of supply: the weak dynamic towards growth in the productive economy.

Some QE advocates will argue it should take place alongside structural reform. This contention ignores the extent to which QE has become a way of avoiding engaging in economic restructuring.??For over two decades the developed economies have used various measures, including credit expansion, to postpone making difficult choices. This was the backdrop to the collapse of Lehman Brothers with low interest rates and high public spending helping to create the conditions for a consumer boom.

Although such measures have eased pain in the short term it only reappears a few years later in a generally more intense form. For example, the 1997-8 Asian financial crisis was followed by the collapse of the technology bubble in 2000 and the 2008-9 recession.

Meanwhile, the dynamic towards growth becomes ever weaker. The productive economy gradually loses momentum as it is not fundamentally restructured.

It would be far better, with less dislocation overall, if weaker economic sectors in each country were allowed to go under. To compensate for the disruption this could cause, the state should encourage the development of new sectors and new points of production.

There are factors making this a particularly good time to pursue such a strategy. The lack of investment in the West in recent decades means that some sectors are already hollowed out. This helps clear the way for new rounds of investment in other areas.

The rise of strong emerging economies could also be an advantage for the West. A larger and more dynamic global economy presents the chance of a more developed global division of labour. Evading difficult challenges through measures such as QE means eschewing opportunities to generate real economic dynamism.