The $600 billion question in G-20.

When the G-20 leaders meet in Seoul, South Korea, today, this is how the discussion would start:

US: We need a balanced growth in the world economy. Some countries cannot run massive current account surpluses while some others run massive deficits. That is unstable and so to achieve a balanced growth we need countries to allow more flexibility in their currencies’ exchange rates - exchange rates determined by market forces.

China: Alright, wait. I have a question before you proceed further – Why is your Federal Reserve printing $600 billion more and flooding the world with liquidity? We are affected by this action of your Fed in two ways –

a. The dollar’s value is artificially weakened thereby giving an unfair advantage to your exports in the global market.
b. It is flooding emerging markets like ours with speculative capital thereby fuelling concerns about asset-price bubbles.

Can you please answer how this is helpful to achieve a stable global economic growth?

US: Look who is talking about “unfair advantage” to exports. Anyways, here is the answer – by doing this quantitative easing (QE2), that is, buying treasury notes/bonds for $600 billion more, we would drive down the long-term interest rates. And by that it means, the borrowing rate on loans, from car-loans to home-loans to you name it, becomes cheaper, thereby fuelling consumer demand. And when demand becomes more, supply has to become more. And for supply to become more, companies will be investing in production, hiring new employees and there comes the job-creation and further demand and further production and further job-creation and the cycle goes on. The economy will then be back on track and US getting its economy on track will the best thing that US can do to the global economy.

Before China could question/talk any further, a guy from the audience-floor gets up to clarify things. He first requests China not to question any further but instead to go home and start diversifying the economy that will depend less on exports and more on domestic consumption than what it is now. He then turns to US to ask/clarify certain things. Oh by the way his name is “Common-Man”.

Common-Man: What you said about QE2 is true but I still don’t get how that would get the economy back on track. Aren’t the interest rates already low enough?

US: But demand is very weak and hence we fear deflation in US. Driving down the long-term interest rates would make sure that demand picks up domestically and with the dollar becoming less in value relative to other countries’ currencies this would also increase international consumption of American goods. All this will lead to job creation in US. Also, all these steps will help Federal Reserve achieve expected inflation, which would make companies who are hoarding cash now to invest thereby creating jobs and demand.

Common-Man: US exports will undoubtedly grow. I agree. Some jobs will be created out of that. I agree. Inflation (that is needed to an extent now) might kick in. I agree. Due to inflation, people and companies will invest instead of hoarding cash that will bring down the unemployment rate. Hmmm, this is where I am not able to completely agree with you. Well, we might see investments occurring, but do you think that just export-led job creation and investments by companies and people to withstand inflation alone would be enough to achieve the expected economic growth and to bring down the unemployment rate that is so high – 9.6%. We actually need hundreds of thousands of jobs to be created every month to bring down the unemployment rate quicker.

US: See, when all I said happens, the cycle will kick in. It might be a slow start but eventually the economic cycle will run faster and we could achieve the needed growth.

Common-Man: Ok to sum it, why is the economic growth so slow and weak?

US: The demand is very weak.

Common-Man: And what are you trying to do to address this?

US: Basically, bring down the borrowing costs further and trigger a little inflation that will force companies to invest.

Common-Man: Ok, from the monetary-policy side, I completely agree with what the Federal Reserve is trying to do – looks like there is no other choice, even though the concerns expressed by some emerging markets about liquidity flooding their markets is genuine and very real. But that’s a topic for later discussion. Also, there is another fear about commodity prices sky-rocketing in the future due to this Fed action. But again, I would like to discuss it later. But I also have to tell you that monetary-policy alone will not be sufficient. It is not that the interest rates are not sufficiently low enough now or that the companies are without cash that is hindering investments. Infact, as per a news article I read (article source below), US companies are sitting on cash equivalent to $1 trillion, without investing. We have to think why? The answer is “uncertainty”. And from the government side, all that is expected is to induce “confidence” in the economy. Until this is done, I am not convinced that we will see enough investments that would bring the US economy back on track quickly. And remember, the more the time it takes, the more is the probability for the unemployment to become structural rather than cyclical (and this is very dangerous).

This “uncertainty” about the future of the economy needs to be beaten by inducing “confidence” in the economy through a tool called – “fiscal policy”. Yes, monetary policy is needed but that alone is not going to solve our problem. It is the lack of a clear, long-term fiscal policy that is creating tensions and fears, not just in US but in the entire world about the stability of the future US economy and thereby the dollar. The question behind the fears of the global companies and community is not “Why are you printing money?” but instead it is the anxiety about – “Ok, you have printed money, now what?”. The world in one way or other will accept the difficulties that will come along with the loose monetary policy that the US is following, provided a confidence is built in them by assurances through a long-term credible US fiscal policy. And the responsibility for this lies directly with the US administration and the US Congress. As long as this concern remains unaddressed, there will be questions and anxiety about the future strength of the US economy and the dollar.

News Article Source:

1. http://finance.yahoo.com/news/US-companies-hoarding-almost-rb-2687745036.html?x=0&.v=1