Why didn’t Ben Bernanke signal a third round of quantitative easing on Friday at the long-anticipated Jackson Hole summit? After all, at the same event last year, the US Federal Reserve chairman made it pretty explicit another funny money missile would be launched.
After Bernanke’s 2010 late-summer missive, and the resulting release of yet more “virtual money”, equities surged on Western markets, the price of all “risk assets” rising by a third over the subsequent six months. By the time QE2 ended two months ago, the Fed had “expanded its balance sheet” by an astonishing $2,300bn since mid-2009.
During last year’s Jackson Hole summit, Bernanke made it clear the biggest economy on earth would be fed another economic sugar rush. The Fed, he signalled, was “prepared to provide additional monetary accommodation through unconventional measures”.
Friday’s speech, though, spent almost no time discussing such measures. There was a cursory mention that the Fed remains “willing to act to promote a stronger economy” but only “as appropriate” and only “in a context of price stability”. The overall impression was that America’s central bank is now rather reluctant to reboot the virtual printing press, certainly compared with last year.
Why is this? The stated aim of QE is to bolster economic confidence and promote growth. Well, the US economy now looks far weaker than last summer. Just before Bernanke’s 2010 speech, figures showed the American economy expanded an annualised 1.6pc during the second quarter. Last week’s effort was presaged by much worse news – the second quarter of 2011 saw US annualised growth of just 1pc.
American weekly jobless claims just hit 417,000, some 10,000 more than expected. Unemployment is rising sharply. The US is “now dangerously close to recession”, says Morgan Stanley, a verdict borne out by surveys of consumer confidence. The dreaded “double-dip” looms much larger than in August 2010.
On top of that, financial markets are now far shakier than this time last year. During the month before the previous Jackson Hole summit, the S&P 500 dropped 5pc. Over the same period this year, America’s bellwether stock index has endured a rather more shocking 10pc fall. So why no QE3?
One of the given explanations, made clear in Bernanke’s speech, is that US inflation is now rising. So-called “core inflation” hit a 19-month high of 1.8pc in July. That’s admittedly tricky for the Fed, seeing as one of the official justifications for previous doses of QE, is that the US Fed (and the Bank of England) have released virtual money in order to “fight deflation”.
The real motivation behind QE, of course, has been to allow essentially insolvent but politically connected financial institutions to recapitalise themselves. Many QE proceeds have been used to rebuild bank balance sheets rather than stimulate the broader economy. By propping up US Treasury and UK gilt prices, QE has also allowed weak governments, for now, to keep on spending, rather than genuinely tackling our fiscal predicament.
In addition, QE is part of a deliberate but still largely unspoken ploy to gradually weaken the dollar (and pound), so debasing the enormous debts of the US (and UK) governments. “Fighting deflation” has, for the most part, been an intellectual conceit – a deception now made more difficult by the latest inflation numbers. Having said that, if the US authorities had really wanted more QE, they wouldn’t have let a few awkward inflation statistics stop them.
Another reason the Fed has put forward for its new QE reluctance, sotte voce, is politics. The mainstream consensus previously backing QE has collapsed. Republican presidential candidate, Rick Perry, declared that “further money printing” would be “treasonable” – a capital offence. Perry was talking, of course, with an eye on the Tea Party, a political grouping previously dismissed as a joke by beltway politicos. Having made some stunning gains, and getting ever stronger in the run-up to the November 2012 Presidential election, the Tea Party is now taken very seriously indeed.
Again, though, if the White House felt that more QE would have promoted growth and mortgage lending, while giving financial markets a boost, the President would have simply ordered Bernanke to do the business. After all, the economic “feel-good factor” is the ultimate political trump card.
Yet that didn’t happen because there is now a dawning realisation among America’s political establishment that more QE would actually make a bad situation worse. The measures already implemented have been so radical, so unprecedented, that for the Fed to unleash even more QE could easily have been seen as a negative, not only by companies making investment and employment decisions, but even by myopic financial markets.
The Fed may have “looked desperate” – which could have sparked a very serious loss of confidence indeed, another Lehman-style “Minsky moment”. That’s why Bernanke didn’t signal more QE, not squeamishness about inflation or politics.
The reality is QE has already done an awful lot of damage. America has expanded its base money supply three-fold in two and a half years – from 6pc to 18pc of national income. But even this jaw-dropping measure hasn’t led to much of an expansion in monetary measures, such as M2 that include bank lending, precisely because the banks, for all the propaganda to the contrary, are still determined not to lend. They can make more money simply channelling QE money into stocks and other investments.
Crucially, the banks also remain petrified of counter-party risk in the inter-bank market. Many of them, disgracefully, are still concealing vast sub-prime losses in off-balance-sheet vehicles. So they assume other banks are doing the same. Such mistrust between the banks – “we’re lying, so they must be lying” – gums up the wheels of finance and starves even creditworthy firms of the funds needed to invest and create jobs.
That’s why M2 has remained flat, despite a massive expansion of base money. The way to break the deadlock, though, isn’t to do more QE, but to end inter-bank torpor by forcing “full disclosure” of bank losses. Such disclosure is barely happening, on either side of the Atlantic. The UK’s monetary base has also tripled, while producing – for the same non-disclosure reasons as in the US – only minimal growth in M2.
“Full disclosure” will hurt. Some big names will fail, their depositors absorbed by more solvent institutions. Western banking sectors will need to be restructured, as loans are written off. But, as history shows, this process can be managed. “Creative destruction” really is the only way that capitalism can work.
For several years now, QE has plastered over bank losses, so preventing this necessary purging. But the damage goes so much deeper. QE has made commodities more expensive, undermining Western recovery. Imposing “soft default” on the West’s creditors will generate higher future borrowing costs. By sparking justified accusations of foul play by the rest of the world, QE has sparked “currency” wars between West and East, which could yet spiral into tit-for-tat protectionism. And then, think of the future inflation we face, once that huge base money expansion fully enters circulation.
Modern capitalism, at its core, relies on the public’s trust of fiat money and the sanctity of contract. QE, a form of state-sponsored theft, makes a mockery of both those cardinal concepts. That unavoidable truth, having been denied and denied, can no longer be avoided. Not even by the financial markets. And not even by our current crop of cowardly politicians.
Liam Halligan is chief economist at Prosperity Capital Management
This article first appeared in The Telegraph: