FOR the junkies in the markets, the shock news that the Fed’s monetary methadone will continue to flow freely was greeted with jubilation last night. Never mind that QE will only continue at this rate for another few months, and that the delay to tapering was caused by worsening economic growth forecasts, combined with fiscal uncertainty in the US.
Bad news is good news in our brave new world, and so the equity markets went ballistic: all asset prices rose, the S&P 500 reached record highs, stock markets in emerging markets shot up, the price of oil jumped and the FTSE will rocket this morning. Bond yields fell – the Fed is unimpressed with soaring yields and the deflating bonds bubble – and gold soared.
Why, you may ask, am I so upset? Astonishingly, a few tens of billions more QE has boosted global financial wealth by two per cent or so. So why do I think Ben Bernanke was so misguided? Even “market monetarists” such as Scott Sumner agree with him. So what’s wrong with me? I have no interest in being a kill-joy when so many are celebrating. It’s just that, long-run, I don’t think that any of this is the right approach to build sustainable prosperity.
In fact, I’m convinced that the costs of QE and very low rates are now unambiguously larger than their benefits. Even if the doves are right that tapering now would slow GDP growth, I believe that the side-effects of monetary activism – a massive distortion of relative prices and the creation of immense bubbles, not just in the US but all over the world – have become terrifyingly large. There’s more to an economy’s health than GDP statistics. Better a bit less growth over the next year than a catastrophic implosion in two or three years’ time that would make the Great Recession that began in 2007-08 look like a tea party, and send unemployment through the roof.
One of the great costs of our current monetary policy consensus is that it has robbed stock, bond and many other prices of much of their informational value. They no longer properly reflect the decisions and tastes of millions of individuals, or the relative scarcity of goods, services and capital. The US stock market reached an all-time high yesterday not because long-term profits are now expected to rise, or because of genuine shifts in the supply and demand of loanable funds. It rose merely because of the Fed and a few tens of billions more in QE. None of these prices are properly being determined by the free-market any more, and this will have horrendous consequences over time on the capital structure of the economy, the allocation of resources and on people’s wealth. It will undermine the City’s legitimacy and those who make money from investing and trading.
Most central bankers are making a fatal error: the belief that the micro-management of aggregate demand is the answer to all of our problems. It isn’t. Of course, the Fed was right to act when the economy began to implode: one (but not the only one) of the great lessons of the 1930s depression, as expounded by Milton Friedman and Anna J Schwartz in A Monetary History of the United States is that the money supply should never be allowed to collapse. But to agree to that proposition is very different from thinking that policy should respond to every blip in data, every worry about construction output. For all the talk of rules, the status quo is about extreme discretion.
At issue is a classic confusion. Monetary stimulus can help economic activity in the short-term – but not in the long-term, when what economists call real factors such as productivity growth determine output, jobs and wages. The US economy is suffering from a real, supply-side crisis, with wages under pressure and fewer people finding work. No amount of QE will solve this. Ben Bernanke is tilting at windmills. It will all end in tears.