Austerity, QE2 and the Global Economy

 November 2, 2010

Last week’s top-level political meetings which took place in Brussels and Hanoi ended up with similar calls on the US to avoid stimulating the American economy by printing more dollars. Trying to stimulate growth by flooding the American banking system with liquidity is only of marginal importance to the US economy’s woes. Yet this is exactly the measure that the Federal Reserve is contemplating this week, one known euphemistically under the name of QE2 – which stands for the second quantitative easing. The measure involves the spending of minimum 500 billion US dollars by the Fed to buy assets like treasury bonds back from banks and thus infuse more liquidity in the banking sector, ultimately benefitting potential borrowers.

The “easy money” measure bears all the hallmarks of Friedman’s monetarist theories. According to him and his followers, a financial crisis is aggravated by a lack of adequate liquidity within the banking sector. Tackling the liquidity problem is deemed to reignite economic growth.

The Fed’s move will further lower the exchange rate of the US dollar and cause the appreciation of other currencies worldwide. Already, the Japanese yen is at a 15-year high against the dollar. In the past few months, the Thai baht has risen by 11 percent, the Philippine peso by 7 percent and the Brazilian real has acquired the unenviable reputation as the most over-valued currency on earth. Since this summer, the euro has also risen by 9 percent to 1.39 dollars, badly affecting exports and the feeble economic recovery of 2009-2010 as well.

The draconian austerity measures recently adopted within the EU, combined with a printing of money by the United States are thus further endangering an already anemic economic growth in the West. The situation is so serious that even a publication like The Economist has felt compelled to finally incriminate austerity and money-printing, as the wrong policies for leading the global economy back to a sustained growth pattern :

“there is a danger of overdoing the short-term budget austerity. Excessive budget-cutting poses a risk to the recovery, not least because it cannot easily be offset by looser monetary policy. Improvements to the structure of taxation and spending matter as much as the short-term deficits.”

Fiscal stimuli, not austerity, and changes to “the structure of taxation” (!) are therefore the policies needed to bring the global economy back to 2007 output and performance levels (which, by the way, The Economist does not expect to happen before 2015 !).

As worried central bankers from Frankfurt and Tokyo will also meet this week, it will be interesting to see what countermeasures, if any, they will decide upon in response to the Fed’s expected QE2 decision. Unfortunately, even central bankers disagree when it comes to measures like austerity, fiscal stimuli and changes to taxation levels, let alone Western politicians under pressure from their electorates to cut taxes further or to reduce the size of government payrolls. With an expected Republican win in the US midterm elections and with conservative politicians in power in the EU’s leading countries, the outlook is rather gloomy. The continuation of current policies will see the Western world condemned to a Japanese-type decade of economic stagnation or, at best, sluggish growth.

Meanwhile, the Chinese economy will ring up another decade of stellar growth rates, if current and past trends are any guide.