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Money, money everywhere: the issue is not liquidity, but demand

Money, money everywhere: the issue is not liquidity, but demand

US poll outcome and QE2 offer stalemate rather than stimulus

by Darrell Delamaide

Thu 4 Nov 2010

In a move many economists had branded ahead of time as too much of a good thing, the US Federal Reserve has announced a new round of quantitative easing, or QE2, saying it will purchase an additional $600bn of long-term Treasury securities between now and June.

The much-heralded announcement came the day after US voters gave President Barack Obama and his Democratic Party a long-expected thumping in mid-term elections, handing the Republicans a strong majority in the House of Representatives and sharply reducing the Democratic majority in the Senate.

The twin outcome adds up not to stimulus but to stalemate - with a capital S. Voters look set for more frustration as the policy tools being employed resemble so many spinning wheels. The one policy that history tells us could work – boosting aggregate demand through government deficit spending – is now off the table, thanks to the ineptitude of the Obama administration and the relentless brainwashing of the American public by deficit hawks.

The results made it all but certain that tax cuts previously decided under George W. Bush’s administration will be extended for all levels of income. Equally likely, there will be no new government spending measures to stimulate the economy.

But since the banking system is already awash in liquidity and taxpayers of all stripes will either hoard their tax savings or pay down debt, neither QE2 nor renewed tax cuts are likely to give the US economy the boost policymakers are seeking in order to reduce unemployment.

The Federal Open Market Committee painted a grim picture of the US economy to justify its monetary accommodation: ‘Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit,’ the panel said in its statement after meeting on Tuesday and Wednesday. ‘Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in non-residential structures continues to be weak. Employers remain reluctant to add to payrolls.’

Both President Obama and House minority leader John Boehner, now poised to become speaker of the House when the new Congress convenes in January, said the message from the election was that voters are frustrated by the slow pace of the recovery and job creation.

However, Fed officials made clear ahead of this week’s announcement that they don’t expect QE2 to stimulate the economy through the credit mechanism, which is simply not functioning at the moment, but through some knock-on effects.

One is that reducing Treasury yields even further will push investors into riskier assets, creating a wealth effect that will spur spending and also encouraging companies to invest in new capacity. New capacity to do what, however? Consumers are still not buying things.

As for pumping up the value of other assets, this runs the risk of creating new bubbles. For instance, both high-yield bonds and leveraged loans have experienced a resurgence in recent months. The funds raised have gone to non-productive purposes such as leveraged buyouts and share buybacks, and are uncomfortably reminiscent of the financial gimmickry that caused the post-2007 crisis.

The other benefit Fed officials see from QE2 is a boost for US exports as the dollar loses value. This is a somewhat forlorn hope in the case of the American economy since it produces too little aside from jet airliners and farm equipment that people in other countries want to buy.

The core problem of a slump in US consumer demand remains unaffected, with all the consequences that implies for the world economy. The potentially negative outcome would hit China first of all, but, through its ripple effect, would extend to exporters like the Germans, who somewhat smugly, and perhaps mistakenly, attribute their success to their own virtue. So, almost certainly, the number of people around the world experiencing pangs of queasiness about the new US measures will significantly outstrip those feeling upbeat.

Darrell Delamaide is a member of the OMFIF Board of Contributing Editors.

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