30 June 2010

Buttonwood on quantitative easing

I just spotted an interesting Buttonwood post from earlier in the month.

“Given that economies may have to slam on the fiscal brakes, and that interest rates are already near zero, central banks may be forced into other means of boosting the economy, in particular quantitative easing or QE. I confess to being rather cynical about QE. We know of occasions in history when it didn’t work (Japan) and we know when it resulted in hyperinflation (the Weimar republic). We don’t know of any occasions when it definitely did work.”

It goes on:

“how about thinking of the last 40 years as one long bubble, in which fiat money has led to asset price inflation. Before you dismiss the idea, think about this; with gold at $1250 an ounce, the dollar has lost 97% of its purchasing power in terms of what used to be though of as “real money” since 1971. The Romans took 200 years to achieve the same effect, cutting the amount of silver in their coins by 96%…Go back to the early 18th century and there was another experiment with fiat money conducted by John Law on behalf of the French regent. Law was hired to improve the regent’s finances and believed that a shortage of currency was holding back French growth. His clever scheme combined QE, subprime lending and an emerging markets fund….it is possible to argue that the development of the bubble mentality has distorted monetary policy, led to the rise of an overpowerful rent-seeking financial sector, and in the Anglo-Saxon economies, led to the excessive focus of investment in housing. Some of this wealth may prove illusory and just like John Law, attempts to prop up asset prices that have lost relationship with the wealth of the underlying economy, may end up being a failure."

As Buttonwood points out, with interest rates so low (lower at Bank of England than at any time since it was founded in 1694) and European governments now attempting to reduce their deficits, quantitive easing is almost the only tool left to prevent aggregate demand and asset prices falling.

The Economist is doing its usual trick of attempting to communicate its alarm to readers without sounding too alarmist.

And the prospect is pretty alarming. The continued purchases of Government debts by central banks are just about all that is now standing between us and financial failure.

See Bubble history

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