In the large developed countries, the state of the economy can be very simply summarized: the inmates have taken over the asylum. It is hardly coincidental that an aphorism ascribed (apparently erroneously, but who cares?) to Albert Einstein, to the effect that “the definition of insanity is doing the same thing over and over again, while expecting a different outcome”, has become immensely popular in the economic blogosphere of late. Nothing better reflects the reaction of a large number of economists – including many mainstream academics – to the latest round of massive monetary intervention on the part of the developed world’s central banks.
The largest such effort was that unveiled by the Federal Reserve last week, in the form of the long-awaited “QE3”. Fed chairman Ben Bernanke pledged to buy $40 billion worth of MBS (mortgage-backed securities – i.e. bonds that represent bundles of mortgages packaged together and sold to investors) every month, and to continue doing so until such time as the American labor market improved. If the desired improvement did not occur – meaning if the official unemployment rate did not come down, although there is a great deal more wrong with the labor market than the headline unemployment rate – then the Fed would simply buy more bonds, or maybe even other securities.
This announcement, for which the financial markets had prayed and hoped for all year, was greeted with general dismay among professional economists. On the one hand, the Keynesian camp led by Paul Krugman, who believe that the ongoing economic crisis is the result of deficient demand and that governments should therefore spend more, actually dismissed this move as insufficient. On the other hand, the growing number of economists (including former members of the Federal Reserve Board and/or regional chairmen) who have concluded that previous rounds of QE have failed to spur economic recovery, saw this latest effort as the kind of insanity defined above.
Indeed, many critics noted that the sheer scale of Bernanke’s move – almost half a trillion dollars per annum of purchases, open-ended both in terms of time and also the potential scale if deemed necessary – was extremely worrying. If this is what the Fed believed was needed at a time when the American stock markets are at multi-year highs and economic activity is still growing, albeit very sluggishly, what would it do in a recession, or in a financial crisis?
One potential answer would be to emulate the Japanese example. The Bank of Japan has been engaged in “quantitative easing” for much longer, and on a much larger scale, than the Fed (with no discernible benefit to the Japanese economy, which remains mired in deflationary stagnation) – and it has gone so far as to buy shares and other financial assets in times of crisis. The Japanese confirmed their addiction to QE – in other words, their apparently irremediable insanity – by announcing another round on Tuesday. This caused the markets to jump, but the impact faded within hours and was expunged entirely before a day had passed – thereby confirming the view that these acts of monetary insanity suffered from sharply diminishing returns.
Meanwhile, the data continue to show that the Chinese economy is slowing down, but the Chinese authorities have refrained from undertaking the kind of large-scale stimulus that the Americans and Japanese favor. The contrast could hardly be greater – whilst US markets responded to Bernanke by surging to new highs in the recovery that began in March 2009, the Chinese markets have fallen to levels close to their late-2008 lows. There is considerable debate as to why Chinese economic policy is not more “aggressive”, but the fact is that the aggression on display in China this week has been verbal and even physical, directed against Japan and the US over nationalist issues – with the only link to monetary policy coming in the form of demands to dump Chinese holdings of Japanese government bonds.
Meanwhile, in Europe we are witness to a remarkable spectacle. European Central bank president Mario Draghi seemingly led off the latest round of monetary intervention two weeks ago, by announcing “open-ended” and “unlimited” purchases of the government bonds of EU countries with maturities of less than three years. This was hailed as nothing less than a “game-changer” which opened the way to a “final solution” (no less!) of the long-running European sovereign debt crisis. In fact, it is nothing of the sort, because the causes of the crisis are far too deep to be solved by monetary maneuvering.
But the beauty of the Draghi gambit is that, unlike Bernanke, he has done nothing so far and may never do anything. His “massive”, “open-ended” intervention is predicated on a) the country whose bonds are to be bought officially requesting help from the EU and its bail-out mechanisms and b) the country accepting the conditions (austerity etc.) that come with the rescue. So far, Spain has refused to do the former and the Spanish people seem very loth to accept the latter. Draghi’s promises have yet to cost a single euro, they are all smoke and mirrors – but so long as the illusion persists, everyone is content. Call it the poor man’s version of insanity: pretending to do the same thing as before and pretending to believe no-one will notice.