Monday, November 08, 2010


No, not the ship!

Rather the second round of "quantitative easing" (printing more money) by the US Federal Reserve!

To put the matter fully: a friend asked my view about the decision of the Fed to to add $600 billion of fresh liquidity to the USA.

Here is my response:

Isn't it ironic that after the election triumph of the Tea Party, the US public is confronted with yet another splurge of liquidity creation.

However, this splurge is simply another desperate effort to ignite the recovery of the US economy - which will continue to fail to work, for the reasons I outline below (when seen merely in the US national context; when seen in the global context other reasons for the failure of this effort will also become evident).

1. The dollar will fall further in international markets. Though this will incentivise some foreigners to invest in the US (as US assets will then be relatively cheaper for foreigners to buy), it will disincentivise others whose existing investments (bonds, equities, et al) will be hurt by the fall of the dollar. No doubt the Fed has done its calculations on this - and one can only hope that its calculations are proved right.

2. While a cheaper currency might be expected to help exports, and may indeed do so, that won't help job-creation because an increasing amount of the output of "American companies" comes from workers abroad.

3. While this QE will continue to provide a floor to the economy itself, it will not create substantial lending to the mass of business and, even if it did so, will not incentivise the mass of such businesses to employ US citizens. Why? Among other things, because most work that needs to be done, whether in manufacturing or in services, can be done much more cheaply in countries, such as China, which do not care for basic environmental and human considerations (whatever their protestations to the contrary, and whatever token gestures they may stage in these directions). That is why so much outsourcing of jobs has gone on - and will continue to go on.

My conclusion:

If the US wants to sustainably improve its economy and sustainably increase employment inside the US, it will have to either withdraw from the WTO, or reform the WTO so that the treaty's rules integrate minimum pay, pensions, holidays, health, safety, and environmental standards - as well as agreed rules regarding how much money can be printed relative to GDP, how bad loans are categorised, calculated and registered, and so on. This will necessitate extending to the whole of the WTO the sort of work that is intended to be undertaken by the newly-established Office of Financial Research which the Dodd/ Frank Act at present implicitly limits to the US.

I am assuming (perhaps wrongly?) that Spencer Bachus or whichever other Republican eventually chairs the new House financial services committee will not "roll back" the few good things that the Dodd/Frank Act has put into place such as the Volcker rule's ban on proprietary trading and the restrictions on banks’ investments in hedge funds and private equity firms.

Given the possibility of such a roll-back, it is perhaps worth revisiting the (still largely-unaddressed) issues at the heart of the current crisis:

- too much liquidity as a result of the delinking of currencies from anything beyond the say-so of a government or central bank (I am interested to see Zoellick's proposal to include gold as an indicator in the global financial system, and will comment on that separately);

- too much (vastly multiplied!) speculation as a result of the elimination of the Glass-Steagall Act and of the possibility of unlimited leverage (which had already led to the LTCM crisis, but we refused to learn from it!)

- too much opacity in the financial system (the creation of the "shadow financial system") following the government's encouragement of non- and near-banks, and then encouraging recognised banks to participate in and emulate their activities, topped by the abolition of the need for the "big boys" to register their financial activities as a result of the Gramm-Leach-Biley Act which led to banks ceasing to trust each other - which is what actually finally caused the crisis triggered by speculation and the resulting sub-prime defaults;

- overly-lax provisions for Special Purpose Vehicles, intended to encourage off-balance-sheet activities (which torpedoed Enron et al - but we refused to learn any lessons from that beyond imposing expensive and only partially necessary SOX on everyone);

- too much reluctance on the part of authorities to impose (and of executives to accept) any system of accounting that will enable right evaluation of risks in companies and in the financial system, such as can easily be done);

- too much short-termism due to the current structure of the "institutions" of exchanges, shares and frequent trading (in relation to which I have already proposed solutions).

If 90% of all "financial innovation" over the last few decades has focused on nothing more than regulatory arbitrage, what we need is global rules covering the crucial matters I mention above.

Global business activity cannot be conducted on a sustainable basis in the absence of sensible minimum global rules that create a level playing field on which the best players can win on the basis of innovation, quality, service and other good things - rather than the present system where those qualities may be rewarded but other rather worse things (such as environmental degradaton and human exploitation) are rewarded even more.

Regrettably, there is so far little sign that most people in the US (or indeed most of their political, economic and cultural leaders) are willing to recognise such basic facts. Sphere: Related Content

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