Will they have the nerve to call the next phase QE2?
- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -
It is hard to be too pessimistic about the economic outlook for the rich countries, and impossible as far as the UK is concerned. With every day that passes, it becomes clearer that, far from being out of the woods, we are once again plunging into recession and possibly crisis.
Wednesday we had news that in Germany, the least-indebted, and apparently best-balanced of the big industrialised countries, one of the largest banks has reported write-downs exceeding forecasts for the final quarter of 2009, and the well-respected IFO Institute is reporting an unexpected fall in business confidence.
In both the UK and the U.S., the index of confidence fell this month – but that is far less surprising, as the penny drops that both are economic basket cases.
There are two ominous sign. In the housing market, where the crisis started, the green shoots of recovery that were spotted by the Prozac-poppers in the equity markets appear to be withering fast. In fact, after an artificial boost due to concessions on stamp duty, the UK’s Council of Mortgage Lenders reckons gross lending in January was 20 percent below its level 12 months ago at what many people thought at the time was the low point of the crisis. Stand by for another fall in house prices.
With one black cloud apparently returning, another is already darkening the horizon. In the post-Lehman panic, investors rushed to buy “safe” government debt, apparently failing to notice that Washington and London are to thrift what Las Vegas is to moral philosophy. In gratitude for this vote of confidence from the bond markets, both the UK and U.S. administrations decided to party as if the world were coming to an end, which in a sense is what now seems likely to happen, as investors wake up to the realisation that 4%+ is a meagre reward for a 20-year loan to Obama, Brown or their likely successors.
The lack of transparency would shame a Chinese or Japanese multinational. In effect, quantitative easing – verbal camouflage for “printing money” – amounts to issuing new Pounds and Dollars so as to buy back the Government’s own debt, which would be an exercise in futility if markets were remotely rational.
But, in the same way that big companies use their own funds to buy back their stock, a tactic which ought to have no effect on its price (but does), so the UK and U.S. governments have been propping up the price of their bonds, to an extent that will only become clear when they stop the merry-go-round. No wonder there is nervousness in the corridors of erstwhile economic power, and in the markets too.
Fortunately for both countries, however, the markets seem as incapable as ever of focussing on more than one crisis at a time, and right now the Eurozone is the crise du jour. Looking at the credit default swaps market, it is clear they are now starting to worry about problems spreading from ClubMed into the heart of Europe, with France’s debt costing 58 basis points to insure and even Germany’s 43 b.p.
The latter figure, which is virtually the same as for US Treasury bonds, can only mean that markets have finally arrived at the obvious conclusion: if Greek (and Portuguese and Italian and Spanish) bonds are guaranteed safe, then the guarantor must be taking on an awful lot of risk.
It cannot be emphasised enough that, although the scale of the belt-tightening required of both UK and USA in order to pay off their debts in honest currency is without precedent in peacetime, we do have one option which is not open to Eurozone members.
If repaying in honest money is too onerous a burden, we can always repay in dishonest, devalued currency – in fact, we’ve already made a start with QE (Will they have the nerve to call the next phase QE2? Titanic would be more appropriate). This escape route via devaluation is closed to Greece and Portugal and the other Eurozone member countries…….but not of course to Germany, which could always count on French support for monetary relaxation, setting the scene for a global war of competitive currency depreciation.
And then we have to wonder about the impact of all this on politics………..