Traders at the New York Stock Exchange on Wall Street, where there was a big sell-off last week. Photograph: Richard Drew/AP
Financial markets have become stimulus junkies. They crave their next fix of quantitative easing
and when they don't get it they turn ugly. The rush they get from the
drug wears off after a while, and then they become needy and whiny.
Witness last week's sell-off on Wall Street following the hint from the Federal Reserve that it was about to cut off the drug supply.
A similar dependency exists in the UK, where stock market traders expectantly await an injection of QE, courtesy of the Bank of England, after deterioration in the UK's economic outlook. Governor Sir Mervyn King voted for another £25bn of cheap money and his colleagues should endorse his view in the coming months. The loss of the UK's much coveted AAA status, thanks to the credit ratings agency Moody's on Friday night, is likely to make the markets salivate even more.
The prospect of US policymakers taking the opposite view, and raising interest rates, prompted a bit of soul-searching. The markets have rallied strongly since the middle of 2012, but appeared acutely vulnerable to the suggestion that monetary conditions might at some point return to something like normal. For those who don't have long enough memories to remember what normal is, that would be a world with official interest rates between 3% and 5% and where the electronic printing presses are mothballed.
The situation today is the closest the world has been to a depression since the 1930s. Then, Keynes said a depression was a "chronic condition of subnormal activity for a considerable period without any marked tendency towards recovery or towards complete collapse". The global economy has exhibited all these traits since the deep slump of 2008-09. Growth has been sub-par for a long period. There is no real sign that output is about to slump as it did four years ago, but the sort of strong recovery expected after previous post-war recessions has proved elusive. It's a depression all right.
Analysts at Morgan Stanley say we are on the brink of the third wave of global monetary easing. Phase one came in the winter of 2008-09 when interest rates were slashed virtually to zero and quantitative easing was introduced as a "temporary" measure. The drying up of credit meant the money supply was contracting and there was a fear of being sucked back to the 1930s. The hard economic data at the time suggested this was a genuine prospect. So money was made cheap and plentiful, just as Keynes would have suggested.
But by late 2011, the global economy needed another fix of the monetary stimulus drug. In part, this was because the drugs had side-effects – QE led to asset-price speculation which pushed up commodity prices, which in turn raised business costs and cut the real incomes of consumers. In part, it was because certain finance ministers – no names, no pack drill – tried a course of cold turkey too soon. In part, it was because the eurozone crises hit the rest of the world.
Now we are entering the third phase of monetary easing. The Bank of Japan will push inflation up to 2%, using a combination of monetary easing and fiscal stimulus. Mario Draghi has been talking tough at the European Central Bank but is contemplating cutting borrowing costs in response to a eurozone economy that failed to grow in every quarter of 2012 and is still heading south. The Bank of England has decided to adopt a "flexible approach" to the government's 2% inflation target and looks likely to increase its QE programme to £400bn within the next couple of months. And so it goes on. With its housing bubble about to pop, the Bank of Canada has cooled off the idea of tightening policy, while the central banks in Sweden and Australia left interest rates unchanged in February but maintained their bias towards easing. As for the Fed, anybody who thinks the US central bank is about to toughen its stance hasn't been paying attention.
The US is obsessed by the Great Depression. It is the single biggest economic event of American history and is embedded in the national psyche. Ben Bernanke, the chairman of the Federal Reserve, made his mark by studying the policy errors of the 1930s and is determined not to repeat one of them: an over-tight monetary policy. America's recovery has been modest by historical standards. Unemployment has remained much higher than the Fed would like, and it wants to see the jobless rate below 6.5% before it even thinks about tightening policy. Even that might not prompt action, according to the Fed's vice-chairman Janet Yellen.
David Brown, of New View economics, says: "We are back to bubble economics and the super-accelerant added by the central banks is the propellant that will take this rally back above the upper hemisphere in the coming years."
He adds: "The Fed is going to be the last agent that will want to upset the applecart on the risk-on revival to date. It has plied the markets with more liquidity than anyone else. It wants risk-on. It wants irrational exuberance. It wants four dimensional easing – easy money, easy rates, easy currency and easy fiscal policy. It wants stronger growth and the lower cost of capital to markets is all part of that plan. Strong equity markets and stronger financial wealth perceptions are central to this. If consumers feel wealthier because their stocks go up and house prices start to stabilize, then that is part of the game-plan too."
This all may sound eerily reminiscent of the world before the meltdown. That's because it is. The repair job on the US economy is more advanced than that in Europe, and there is a real chance of an industrial renaissance in the years to come. Energy is cheap, China has lost some of its labour-cost advantage, higher oil prices are making it far less advantageous to outsource. Manufacturing jobs are coming home.
That said, the repair job is incomplete. Three factors should be of concern to US policymakers: the high levels of debt to income even after the de-leveraging of recent years; the pressure on real incomes from low wages; and the risk that political gridlock in Washington over raising the debt ceiling will lead to an inappropriate tightening of fiscal policy that will lead to a recession in the first half of 2013.
A fiscal impasse between Democrats and Republicans is a far bigger short-term threat to the US economy than a slower pace of quantitative easing or the withdrawal of monetary stimulus at some point in the future. The danger is that a failure to reach agreement will trigger across the board spending cuts under the sequestration agreement reached between the White House and Capitol Hill in the summer of 2011.
The combination of spending cuts and the higher payroll taxes that came in at the start of the year will lead to lower demand and higher unemployment. Financial markets will freak out, and the response from the Fed will be – you guessed it – further monetary stimulus. Wall Street is convinced it could stop taking the drugs any time it likes. But don't all junkies say that? The fact is that nobody knows for sure how this will all play out. Welcome to the opium den.
A similar dependency exists in the UK, where stock market traders expectantly await an injection of QE, courtesy of the Bank of England, after deterioration in the UK's economic outlook. Governor Sir Mervyn King voted for another £25bn of cheap money and his colleagues should endorse his view in the coming months. The loss of the UK's much coveted AAA status, thanks to the credit ratings agency Moody's on Friday night, is likely to make the markets salivate even more.
The prospect of US policymakers taking the opposite view, and raising interest rates, prompted a bit of soul-searching. The markets have rallied strongly since the middle of 2012, but appeared acutely vulnerable to the suggestion that monetary conditions might at some point return to something like normal. For those who don't have long enough memories to remember what normal is, that would be a world with official interest rates between 3% and 5% and where the electronic printing presses are mothballed.
The situation today is the closest the world has been to a depression since the 1930s. Then, Keynes said a depression was a "chronic condition of subnormal activity for a considerable period without any marked tendency towards recovery or towards complete collapse". The global economy has exhibited all these traits since the deep slump of 2008-09. Growth has been sub-par for a long period. There is no real sign that output is about to slump as it did four years ago, but the sort of strong recovery expected after previous post-war recessions has proved elusive. It's a depression all right.
Analysts at Morgan Stanley say we are on the brink of the third wave of global monetary easing. Phase one came in the winter of 2008-09 when interest rates were slashed virtually to zero and quantitative easing was introduced as a "temporary" measure. The drying up of credit meant the money supply was contracting and there was a fear of being sucked back to the 1930s. The hard economic data at the time suggested this was a genuine prospect. So money was made cheap and plentiful, just as Keynes would have suggested.
But by late 2011, the global economy needed another fix of the monetary stimulus drug. In part, this was because the drugs had side-effects – QE led to asset-price speculation which pushed up commodity prices, which in turn raised business costs and cut the real incomes of consumers. In part, it was because certain finance ministers – no names, no pack drill – tried a course of cold turkey too soon. In part, it was because the eurozone crises hit the rest of the world.
Now we are entering the third phase of monetary easing. The Bank of Japan will push inflation up to 2%, using a combination of monetary easing and fiscal stimulus. Mario Draghi has been talking tough at the European Central Bank but is contemplating cutting borrowing costs in response to a eurozone economy that failed to grow in every quarter of 2012 and is still heading south. The Bank of England has decided to adopt a "flexible approach" to the government's 2% inflation target and looks likely to increase its QE programme to £400bn within the next couple of months. And so it goes on. With its housing bubble about to pop, the Bank of Canada has cooled off the idea of tightening policy, while the central banks in Sweden and Australia left interest rates unchanged in February but maintained their bias towards easing. As for the Fed, anybody who thinks the US central bank is about to toughen its stance hasn't been paying attention.
The US is obsessed by the Great Depression. It is the single biggest economic event of American history and is embedded in the national psyche. Ben Bernanke, the chairman of the Federal Reserve, made his mark by studying the policy errors of the 1930s and is determined not to repeat one of them: an over-tight monetary policy. America's recovery has been modest by historical standards. Unemployment has remained much higher than the Fed would like, and it wants to see the jobless rate below 6.5% before it even thinks about tightening policy. Even that might not prompt action, according to the Fed's vice-chairman Janet Yellen.
David Brown, of New View economics, says: "We are back to bubble economics and the super-accelerant added by the central banks is the propellant that will take this rally back above the upper hemisphere in the coming years."
He adds: "The Fed is going to be the last agent that will want to upset the applecart on the risk-on revival to date. It has plied the markets with more liquidity than anyone else. It wants risk-on. It wants irrational exuberance. It wants four dimensional easing – easy money, easy rates, easy currency and easy fiscal policy. It wants stronger growth and the lower cost of capital to markets is all part of that plan. Strong equity markets and stronger financial wealth perceptions are central to this. If consumers feel wealthier because their stocks go up and house prices start to stabilize, then that is part of the game-plan too."
This all may sound eerily reminiscent of the world before the meltdown. That's because it is. The repair job on the US economy is more advanced than that in Europe, and there is a real chance of an industrial renaissance in the years to come. Energy is cheap, China has lost some of its labour-cost advantage, higher oil prices are making it far less advantageous to outsource. Manufacturing jobs are coming home.
That said, the repair job is incomplete. Three factors should be of concern to US policymakers: the high levels of debt to income even after the de-leveraging of recent years; the pressure on real incomes from low wages; and the risk that political gridlock in Washington over raising the debt ceiling will lead to an inappropriate tightening of fiscal policy that will lead to a recession in the first half of 2013.
A fiscal impasse between Democrats and Republicans is a far bigger short-term threat to the US economy than a slower pace of quantitative easing or the withdrawal of monetary stimulus at some point in the future. The danger is that a failure to reach agreement will trigger across the board spending cuts under the sequestration agreement reached between the White House and Capitol Hill in the summer of 2011.
The combination of spending cuts and the higher payroll taxes that came in at the start of the year will lead to lower demand and higher unemployment. Financial markets will freak out, and the response from the Fed will be – you guessed it – further monetary stimulus. Wall Street is convinced it could stop taking the drugs any time it likes. But don't all junkies say that? The fact is that nobody knows for sure how this will all play out. Welcome to the opium den.
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