Central bankers have faced today's crisis before. But their new weapon, quantitative easing, could make the mess worse.
Japan was the world’s most admired economy in the ’80s. Then it was the world’s most despised economy in the ’90s. By 1995, economists pointed their fingers and laughed – the world’s most admired businessman had lost his left shoe.
But now, much of the world is barefoot. The US inflation rate has been going down since the early ’80s and was cut in half since last year. It now hovers barely above zero. Surely Japan – where prices have been falling for two decades – has something to tell us. As we pointed out last week, the Nipponese have been in decline for the last 20 years – with lower stock prices, falling real estate prices, and a falling GDP. Even the population has been sliding for the last five years
This week the Japanese decided to throw some more grit on the slope. Japan’s central bank governor, Masaaki Shirakawa, said he was boosting his “special loan facility” by 10 trillion yen, about $120 billion. And Mr. Naoto Kan, Japan’s Premier, said he would support the central bank, adding a “second pillar of stimulus’ of some 920 billion yen. The numbers always sound impressive in yen. But they are unlikely to give the economy much traction.
Professors Ken Rogoff and Carmen Reinhart studied 15 economic crises over the last 75 years. What they found was what you’d expect: real recoveries in the post-Keynes era are rare. Instead, in the 10 years following a crisis, economic growth rates are lower and unemployment is higher than in the years preceding the crisis. In two thirds of the episodes, jobless rates never recovered to pre-crisis levels, ever. And in 9 out of 10 of them, housing prices were still lower 10 years after the crisis ended.
“Our review of the historical record, therefore, strongly supports the view that large, destabilizing economic events produce big changes in the long-term indicators, well after the upheaval of the crisis. [Up to now,” the authors warn, “we have been traversing the tracks of prior crises. But if we continue as others have before, the need to de-leverage will dampen employment and growth for some time to come.”]
It was perhaps this scholarly warning that roused Shirakawa to action, with Ben Bernanke right behind. Neither wants to be known as the central banker who followed in the footsteps of losers. Urged on by sages and simpletons, they will print money. “It falls to the Fed to fuel recovery,” writes Clive Crook, one or the other, in The Financial Times. “Under the circumstances,” he writes, “better to print money and be damned.” At last week’s conference in Jackson Hole, Wyoming, the Americans promised to print more money, if needed. Shirakawa rushed home early so he could turn on the presses right away.
We would have more faith in central bankers if they had not been responsible for causing the crisis in the first place. Shirakawa joined the Bank of Japan more than 30 years ago. Ben Bernanke, an expert on the Great Depression, joined the Fed in 2002; he was standing at Alan Greenspan’s right side, with a pin in his hand, years before the bubble reached a crisis level.
“In a sense,” said Professor John Taylor, also at Jackson Hole, “the Fed caused the bubble.” That is, in the only sense that matters – they kept the key lending rate too low for too long. Now they are about to make another monumental mistake. No, two of them.
The first is already in progress. By promising the world extremely low rates for an “extended period” of time, they have created the exact conditions they wanted to avoid. President of the St. Louis branch of the Federal Reserve, James Bullard, explained that the Fed had unwittingly put the economy into an “unintended steady state.” The key rate cannot go any lower as prices sink; it is already at zero. It cannot go higher, either, not as long as inflation remains below the target. So, it does not move. The private sector has come to expect no policy response, Bullard concludes, “so nothing changes with respect to nominal interest rates or inflation.” As in Japan, the US economy remains in a coma.
The second major mistake is still ahead. Quantitative easing is a new weapon. It is not meant to kill dollar holders or bond buyers. It is intended merely to scare them with a little bit of inflation. But with the Fed’s QE shotgun staring him in the face, an investor may doubt the Fed’s promise to pull the trigger “just a little.” He will drop the dollar and US bonds and run. Inflation will soar.
Here at The Daily Reckoning, we have argued that it is coming…but not soon. Our opinion hasn’t changed. We’re just getting tired of waiting.
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