venerdì 12 ottobre 2012
Macro Malpractice, by Stephen S. Roach
The wrong medicine is being applied to America’s economy. Having misdiagnosed the ailment, policymakers have prescribed untested experimental medicine with potentially grave side effects.
The patient is the American consumer – the world’s biggest by far, but now in the throes of the worst funk since the Great Depression. Recent data on consumer spending in the United States have been terrible. Growth in inflation-adjusted US personal consumption expenditures has just been revised down to 1.5% in the second quarter of 2012, and appears to be on track for a similarly anemic increase in the third quarter.
Worse, these numbers are just the latest in what has now been a four-and-a-half-year-old trend. From the first quarter of 2008 through the second quarter of 2012, annualized growth in real consumption spending has averaged a mere 0.7% – all the more extraordinary when compared with the pre-crisis trend of 3.6% in the decade ending in 2007.
The disease is a protracted balance-sheet recession that has turned a generation of America’s consumers into zombies – the economic walking dead. Think Japan, and its corporate zombies of the 1990’s. Just as they wrote the script for the first of Japan’s lost decades, their counterparts are now doing the same for the US economy.
Two bubbles – property and credit – enabled a decade of excessive consumption. Since their collapse in 2007, US households have understandably become fixated on repairing the damage. That means paying down debt and rebuilding savings, leaving consumer demand mired in protracted weakness.
Yet the treatment prescribed for this malady has compounded the problem. Steeped in denial, the Federal Reserve is treating the disease as a cyclical problem – deploying the full force of monetary accommodation to compensate for what it believes to be a temporary shortfall in aggregate demand.
The convoluted logic behind this strategy is quite disturbing – not only for the US, but also for the global economy. There is nothing cyclical about the lasting aftershocks of a balance-sheet recession that have now been evident for nearly five years. Indeed, balance-sheet repair has barely begun for US households. The personal-saving rate stood at just 3.7% in August 2012 – up from the 1.5% low of 2005, but half the 7.5% average recorded in the last three decades of the twentieth century.
Moreover, the debt overhang remains massive. The overall level of household indebtedness stood at 113% of disposable personal income in mid-2012 – down 21 percentage points from its pre-crisis peak of 134% in 2007, but still well above the 1970-1999 norm of around 75%. In other words, Americans have much farther to go on the road to balance-sheet repair – which hardly suggests a temporary, or cyclical, shortfall in consumer demand.
Moreover, the Fed’s approach is severely compromised by the so-called zero bound on interest rates. Having run out of basis points to cut from interest rates, the Fed has turned to the quantity dimension of the credit cycle – injecting massive doses of liquidity into the collapsed veins of zombie consumers.
To rationalize the efficacy of this approach, the Fed has rewritten the script on the transmission mechanism of discretionary monetary policy. Unlike the days of yore, when cutting the price of credit could boost borrowing, “quantitative easing” purportedly works by stimulating asset and credit markets. The wealth effects generated by frothy financial markets are then presumed to rejuvenate long-dormant “animal spirits” and get consumers spending again, irrespective of lingering balance-sheet strains.
There is more: Once the demand problem is cured, according to this argument, companies will start hiring again. And then, presto – an unconventional fix magically satisfies the Fed’s long-neglected mandate to fight unemployment.
But the Fed’s policy gambit has taken the US down the wrong road. Indeed, the Fed has doubled down on an approach aimed at recreating the madness of an asset- and credit-dependent consumption model – precisely the mistake that pushed the US economy toward the abyss in 2003-2006.
Just as two previous rounds of quantitative easing failed to accelerate US households’ balance-sheet repair, there is little reason to believe that “QE3” will do the trick. Quantitative easing is a blunt instrument, at best, and operates through highly circuitous – and thus dubious – channels. Significantly, it does next to nothing to alleviate the twin problems of excess leverage and inadequate saving. Policies aimed directly at debt forgiveness and enhanced saving incentives – contentious, to be sure – would at least address zombie consumers’ balance-sheet problems.
Moreover, the side effects of quantitative easing are significant. Many worry about an upsurge in inflation, though, given the outsize slack in the global economy – and the likelihood that it will persist for years to come – that is not high on my watch list.
Far more disconcerting is the willingness of major central banks – not just the Fed, but also the European Central Bank, the Bank of England, and the Bank of Japan – to inject massive amounts of excess liquidity into asset markets – excesses that cannot be absorbed by sluggish real economies. That puts central banks in the destabilizing position of abdicating control over financial markets. For a world beset by seemingly endemic financial instability, this could prove to be the most destructive development of all.
The developing world is up in arms over the major central banks’ reckless tactics. Emerging economies’ leaders fear spillover effects in commodity markets and distortions of exchange rates and capital flows that may compromise their own focus on financial stability. While it is difficult to track the cross-border flows fueled by quantitative easing in the so-called advanced world, these fears are far from groundless. Liquidity injections into a zero-interest-rate developed world send return-starved investors scrambling for growth opportunities elsewhere.
As the global economy has gone from crisis to crisis in recent years, the cure has become part of the disease. In an era of zero interest rates and quantitative easing, macroeconomic policy has become unhinged from a tough post-crisis reality. Untested medicine is being used to treat the wrong ailment – and the chronically ill patient continues to be neglected.