The chatter has it this week that the US Federal Reserve Bank will allow its $85 billion a month bond buying programme to wane, with the eventual death of quantitative easing and a return to economic normalcy. Not only is it too soon for the Fed to back off, it’s too soon to even be discussing it. The global economy is extraordinarily fragile. We need solutions that are more radical than QE, not a retreat into orthodoxy.
The global economy is threatened by conditions in both developed and emerging markets. In the US and Europe, debt has been transferred from the private to the public sectors and debt levels have climbed faster than economic growth has been able to keep pace. The G7 nations borrowed $18 trillion since the financial crisis and have only $1 trillion in economic growth to show for it.
Meanwhile, both private and public borrowers in the emerging markets have larded up on cheap debt, much of it denominated in dollars and euros. They are borrowing in other currencies and paying with their own, leaving corporate and government treasuries vulnerable to currency shocks, just like we saw during the Asia Crisis of the 1990s.
These are not hypothetical risks; they have already manifested in economic data. Last week, Deutsche Bank analyst Jim Reid and his team released their annual “Long-Term Asset Return” study in which they examine the world’s raw economic output by measuring the world’s “nominal GDP.” Nominal GDP is the value of goods and services produced by the world’s developed and emerging economies without adjustment for inflation. “We live in a nominal world,” writes Reid. “We receive wages, pay our debts and manage our savings in nominal terms.” This is the world economy as the people who live in it actually experience it and, in nominal terms, says Reid, it is growing at its slowest rate since the 1930s.
You have no doubt been told that the global economy is recovering. But the recovery argument rests, in part, on the Fed using the wrong meter for growth. The Fed’s dual mandate requires it to maximise employment while controlling the rate of inflation. Fed Chair Ben Bernanke and his governors have been comfortable with inflation at a maximum of 2% annually, a cue followed by other bankers in the developed world. The problem with this, argues Reid, is that if inflation comes in at anything less than 2%,