The US QE3 Policy Is Doomed to Fail
Zhang Monan
July 30, 2011
Ever since 2009, the US economy has moved along a bumpy course of recovery, the worst it has ever experienced since its economic catastrophe in the 1930s. As a result, it has to turn to policy remedies for a cure. Now deep in debt and with no other way out, it can only dream to rise out of the financial crisis by adopting a loose monetary policy. But if the US Federal Reserve Board opts to keep its quantitative easing (QE) policy, it will surely send the crisis into another run.
Bernanke has recently hinted that his board still needed to wait and see before deciding whether or not to start a new round of quantitative easing, or QE3. According to Bernanke, it is possible for the US economy to remain sluggish for a much longer time than anticipated, and the risk of deflation may arise once gain. To cope with the situation, it would be necessary to provide some policy support. In other words, quantitative easing will not be phased out before the economic recovery moves onto a smooth track.
Although the US economy is rising out of the crisis slowly, its prospect for a full recovery is worrying. According to data from the US Department of Commerce, the adjusted growth of the US economy stood at 1.9 per cent in the first three months of this year, much lower than the 3.1 per cent recorded in the last quarter of 2010 (with the figures for the first, second and third quarter of the year standing at 3.7, 1.7 and 2.6 per cent respectively), a fairly slow pace compared to those recorded in early economic recoveries. According to Ken Goldstein, an economist with the Conference Board, the US economy is now suffering from a periodic slump. What does he mean by periodic slump? He means that the US economy will slump once it is not policy-powered. This is a proof that the US economy has fallen beyond any remedy. Once it loses its hematopoietic function, quantitative blood transfusion may be the only way out.
Without doubt, however, its QE3, if ever adopted, will be doomed to fail. Bernanke made two fundamental mistakes in his understanding of the present-day US economy. First of all, what the US economy is suffering today is not a periodic slump, but a structural headache. Secondly, demand expansion instead of monetary stimulation is the key issue to be tackled in the US economy. The financial crisis and the debt crisis have brought about profound changes to the United States, to its financial institutions, to its enterprises, and to the balance sheets of individual households. This kind of balance sheet recession will go a long course.
First of all, why is it that the blood-making mechanism of the US financial system is emblazed? Due to the outbreak of the financial crisis in 2008, financial institutions exercising risk-hedging liability management have had to kick off the deleveraging process, and lower the proportions of risk assets in their asset portfolios, resulting in a substantial fall of the leverage ratio. On the other hand, the transmission mechanism for the Federal Reserve Board to coin money and that for the banking system to create credits have been blocked up. Due to the growing reluctance to lend on the part of banks, the total sum of credits has been on the fall, while the ratio of cash kept by banks has swelled from a historical average of 3.2 per cent to around 10 per cent of their total assets. Although the extra-quota reserve funds of US banks have risen to around US$1 trillion, consumer credits, business loans, and loans on real estate mortgage in the country as a whole grew at the slowest pace in history. So far as their lending capacity and willingness are concerned, the banks have fallen to a level even lower than they attained before the recession. According to data from the New York Federal Reserve Bank, banks have cut the credit line of credit card holders from US$30,400 to US$26,900 since the start of the currency recovery, and lowered the home equity line of credit from US$1.33 trillion to US$1.15 trillion.
Why is it, then, that the US families are reluctant to spend more? First of all, it takes time for their damaged personal balance sheets to restore, low inflation and slow growth of nominal wages have raised bumps to the deleveraging course, and these families must either repay another debt totaling US$3.3 trillion or earn US$3.9 trillion more to achieve the 84 per cent debt-income ratio as recorded in the 1980s. According to estimates by Credit Suisse, these would amount to the combined income growth in about nine normal years.
Secondly, structural unemployment will be the biggest impediment to consumption growth in the United States. What is haunting the US now is not merely cyclical unemployment, but structural unemployment resulting from deindustrialization due to a years-long drive to transfer its real economy. According to statistics, job offers increased somewhat during the past 6-9 months. The unemployment rate, however, has stood above 9 per cent for three months running. This is a reflection of the matching efficiency of the US manpower markets. In other words, the market capacity of turning job offers into actual employment is going from bad to worse.
This structural unemployment haunting the US first appeared at the beginning of this century, when the wave of globalization accelerated economic depression. From the beginning of this century to December 2007 when the big recession began, emerging economies represented by the BRIC countries stepped up their integration with the world economic system. In order to optimize their exploitation of global resources and sharpen their competitive edges, US businesses have quickened their pace of outbound transfer of manufacturing and outsourcing of services. Without enough rising industries to absorb the workers axed therefrom, structural unemployment began to show up. Statistics have shown that since the beginning of this century, the US working force has seen a net growth of more than 13 million people, while the employment figure has suffered a net loss of one million people. Seen from the comparative advantage of labour cost and productivity, the US does not gain any upper hand over many rising economies so far as the labour cost in its manufacturing sector is concerned. Also, before it pulled down the barriers against hi-tech export, it was Europe that had enjoyed the lion’s share of the high-end market. What the US needs now is reorientation of its development mode and readjustment of its economic structure.
According to forecasts by the Hamilton Project, the US will come to an employment gap of about 21 million. Only by filling up this gap will it hope to bring its economy back to the employment capacity recorded before the start of the recession and absorb the 125,000 job seekers newly joining its workforce every month. Calculated against its current employment growth rate, this gap will remain open for at least 10 years.
Just as the Great Depression was a crisis started by the contradiction between overproduction and deficiency of effective demand, the current crisis is also a result of the contradiction between over-capacity and deficiency of effective demand. For this reason, the attempt by Bernanke to keep the long-term interest rate at a low level and spur expansion of monetary credits will not provide any fundamental solution to the issue of insufficiency of effective demand haunting the United States. While the stimulative policy package masterminded by the US Federal Reserve Board has failed to work, its quantitative policy has produced a spillover effect immediately upon implementation. The continuous depreciation of the US dollar, however, will further exacerbate the fluctuation of the financial market and the bulk stock market, give rise to new bubbles, and tremendously increase the possibility of global inflation, thus sending the financial crisis into another run.
Zhang Monan is an economics researcher with the State Information Center.
