Sugar-Rush Fixes Give the US a Headache

Liam Halligan Daily Telegraph August 30, 2010

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By Liam Halligan Published: 8:26PM BST 28 Aug 2010

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The Western world's central bankers are in a hole. Jackson Hole. The picturesque Wyoming resort has, over the years, become home to an annual wonkfest of elite policymakers and economists.

Ordinarily, the Jackson Hole summit is a time for the central banking A-list to re-convene after the summer, engage in some light discussions and strike rugged poses against a reassuringly mountainous backdrop. This year though, the vibe was more war zone than Woodstock.

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Inter-governmental squabbles about whether more borrowed money should be spent propping up ailing Western economies have recently burst into the open –renewing jitters on global markets.

There is a stark lack of consensus, also, on whether monetary policy should be eased even more, given that official interest rates are already practically at zero. The only way decisively to ease further is to print yet more money – or its modern equivalent, issue more virtual cash.

Such policy differences have escalated in the past few weeks, both within central banks and between them. Important people are now starting to worry that the wildly expansionary fiscal and monetary policies which have been the Western world's response to "sub-prime" aren't working. If that's the case, we have endured all the downside of such extreme measures – in terms of massive government debts, possible sovereign defaults and future inflation – and for what?

Until recently, the US was fulfilling its traditional role of "global economic engine-room", rescuing the rest of the Western world from the worst slump in almost 80 years. President Obama and Federal Reserve chairman Ben Bernanke seemed determined to prove that the world's largest economy could borrow, spend and print its way out of recession.

By Liam Halligan Published: 8:26PM BST 28 Aug 2010

Comments

The Western world's central bankers are in a hole. Jackson Hole. The picturesque Wyoming resort has, over the years, become home to an annual wonkfest of elite policymakers and economists.

Inter-governmental squabbles about whether more borrowed money should be spent propping up ailing Western economies have recently burst into the open –renewing jitters on global markets.

While there have been signs of a US upturn during 2010, the latest news isn't good. America grew at an annual pace of only 1.6pc during the second quarter, way below the government's 2.4pc estimate made just a month ago. On top of that, existing home purchases were down an annualised 27pc in July, hitting a 15-year low. Fears are growing that a fragile housing market will sink US consumption, sending America into the dreaded "double dip" and, with it, much of the rest of the Western world.

The Obama/Bernanke stimulus looks increasingly like a "sugar rush" – it felt good at the time, but provided no long-term economic nourishment. Now that rush is fading, the US is left with an almighty economic headache, but no sustainable recovery.

The ghastly housing numbers in July were at least partly due to the expiry of an $8,000 tax break for first-time buyers. The ending of the cash-for-clunkers car scheme has seen a sharp decline in demand for new cars.

Now the stimulus is drawing to a close, US growth is faltering badly. So does that mean American policymakers will hit the panic button and launch yet another economic rescue package – despite the dangers associated with yet more borrowing and money-printing? Doubts about that question have put global markets in a spin.

In the UK, and across Europe, it seems the choice has been made. While additional monetary easing could still feasibly happen, further fiscal expansion looks unlikely – with governments and a high proportion of voters now saying that yet another spending boost would be not only unaffordable but also counterproductive. American officials have been more circumspect, refusing to rule out another big boost.

Concerns the Western world's recovery has stalled have seen investors pile out of equities and into the perceived safety of government bonds. On Thursday, the Dow Jones Industrial Average of US stocks fell below 10,000 for the first time in almost two months. Meanwhile, the yield on 10-year US government bonds, which moves inversely to prices, hit 2.85pc – its lowest level since January 2009.

Fears of a renewed European recession have sent Germany's 10-year government yield down to 2.15pc, pulling apart the dreaded "PIIGS spread" – the premium that weaker eurozone countries like Portugal, Greece and Spain must pay to service their sovereign debts. That spread is now close to the shocking all-time high, reached back in May, of almost 400 basis points, raising further questions about the ability of the eurozone to hold together.

Japan's markets have also been nervous about the global recovery, with the Nikkei index of leading shares last week slipping back towards a 16-month low.

It was against this dramatic economic backdrop that Bernanke stood up on Friday to deliver his Jackson Hole speech. Addressing market concerns that the US policy establishment is split and a new stimulus may not happen, the Fed boss said America's central bank "will do all it can" to ensure economic growth, including "providing additional monetary accommodation through unconventional measures if it proves necessary".

On cue, the markets rallied, assuming the US will soon launch yet another funny-money missile – under the guise of "quantitative easing". The Dow Jones industrial average closed up 1.7pc.

Back in July 1944, the Bretton Woods conference in New Hampshire created a monetary exchange system that helped the global economy recover from the Second World War, laying the foundations for more than 30 years of relative prosperity. Hopes have been raised that this year's Jackson Hole summit could achieve something similar.

Bernanke's speech, though, and the spin operation that followed it, illustrated once again how little there is in the way of new thinking at the top of the Western world's policymaking establishment. America will continue to print money and borrow like crazy – shielding its profligate, moribund banks and eventually inflating away its sovereign debts. Perhaps the US can get away with it, but the UK and Europe cannot.

While the dollar retains reserve currency status, the markets are now wondering if the single currency could be thrown into the dustbin of history. Further profligacy and money printing on this side of the Atlantic could provoke a collapse of either the euro, sterling or both – causing inflation to balloon.

Similarly, if a renewed US fiscal boost leads the UK's Government to think it can retreat from its stated path of fiscal austerity, it should think again. The balance sheet of America's banking sector amounts to one times US GDP. The UK's banking sector, in contrast, is no less than five times British national income. America can just about afford another bank bail-out – the UK simply can't. Any renewed fears about the systemic implications of the massive sub-prime losses still smouldering on Western bank's balance sheets would, in turn, raise fresh concerns about the UK Government's solvency – given the relative size of the required bail-out.

The most significant economic statement I heard last week came not from Bernanke, but from Mohamed El-Erian. "Current policy approaches here and abroad are unlikely to deliver a durable and robust US recovery," El–Erian declared, in a rejection of QE, Keynesian boosts and related post sub-prime measures.

El-Erian just happens to be CEO of the Pacific Investment Management Company, the world's largest and most influential investor in government bonds. The likes of Pimco, the Chinese government and other massive government creditors hold so many US Treasuries that it's difficult for them to dump them without harming themselves.

The same doesn't apply to their much smaller holdings of European government bonds. Bernanke and Obama know this, which is why the US can keep banging the drum of ever looser money and more profligate government. It's a temptation the UK and the eurozone must continue to resist.

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