Bill Jamieson: Is this desperate Ben Bernanke’s last big bet?

Published on 16/09/2012 00:00

CAN it really be what we’ve waited four long years to see: light at the end of the tunnel at last? Fours year to the week since the collapse of Lehman Brothers sparked a worldwide slump in markets, the US Federal Reserve has resorted to the boldest action yet to kick-start economic growth.

The immediate reaction was a jump for joy across global stock markets. Share prices on Wall Street are now higher than they were when the first cracks in the financial system appeared. So are markets now glimpsing the end of the crisis? Just the beginning of the end would help. And does it in any way alter the economic outlook here?

The announcement by the US Fed made clear that it would continue to buy mortgage-backed securities at the rate of $40 billion (£25bn) a month for as long as it took to achieve a pick-up in growth and a fall in unemployment.

Wall Street jumped immediately. Asian markets followed overnight, while in London the FTSE 100 leapt almost 100 points, or 1.5 per cent, to within a whisker of 6,000 – a level not seen for years.

The Fed also confirmed that its $267bn (£170bn) programme to reduce long-term borrowing costs for firms and households would continue for the rest of the year. In a move dubbed “Operation Twist”, the central bank buys longer-term bonds from retail lenders and swaps them for shorter-term bonds. And, of course, interest rates are to remain at their rock-bottom level of 0.25 per cent.

Last week’s statement from Fed chairman Ben Bernanke had the desperate air of a gambler piling his last chips together with a sweat-stained shirt on “rouge”. The Fed has already tried to boost the economy with two previous bouts of quantitative easing totalling, in aggregate, $2.3 trillion (£1.4 trillion). Yet last week he effectively announced that the result had been a lamentable failure, with a lowering of the Fed’s growth forecast for the US economy this year from the 2.4 per cent forecast, made as recently as June, to 2 per cent.

The formal statement said that “the committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labour market conditions”. The unemployment rate in the US is currently 8.1 per cent and has been above 8 per cent since January 2009.

A popular metaphor over the last decade has compared the role of central banks to that of a prudent householder withdrawing the punchbowl before the party gets out of hand. Last week the influential Lex column of the Financial Times suggested Bernanke had not just left the punch in place but had omitted to add the fruit juice, leaving the partygoers with neat alcohol.

And when it comes to doing “whatever it takes”, it now seems everyone is at it. The move by the Fed follows hard on the heels of the German Constitutional Court giving approval (albeit guarded) to an enlargement of the Eurozone bail-out fund. Mario Draghi, president of the European Central Bank, has primed a massive bond-buying bazooka aimed at cutting the borrowing costs of debt-burdened Eurozone members by buying their bonds. It would, he declared, provide a “fully effective backstop”. Markets have taken him at his word and Eurozone stock exchanges have strongly rallied.

Here in the UK, the Bank of England’s quantitative buying programme has hit £375bn and is likely to be expanded even further before the end of the year.

Taken together, the world’s central banks have capitulated in the face of an intractable slowdown in their economies. Conventional measures have failed to work. Governments, already chronically over-borrowed, do not have the wherewithal to mount a credible Keynesian fiscal stimulus without risking a flight from sovereign bonds.

When the first resort to QE was announced, it came with confident assurances that this extraordinary measure would help to kick-start bank lending to business and thus the business cycle. But, so far, ever-increasing amounts of QE have failed to have the desired effect. And there was nothing in Bernanke’s statement last week that explained why this latest boost would be any more efficacious than previous injections. Nor did there seem to be any undue concern as to its implications for inflation.

The US economy created 96,000 jobs in August, according to official figures – a much lower figure than expected: analysts had been hoping for a figure of 125,000. And revisions to June and July data mean that 41,000 fewer jobs were created than previously reported. The figures also suggest that many have simply given up looking for work. The percentage of Americans who either have a job or who are looking for one fell to 63.5 per cent, the lowest participation rate since 1981. And US manufacturing growth remained sluggish in August amid falling exports and weak employment.

Giving an open-ended commitment to pump in money until unemployment really starts to fall is an extraordinary policy move. It suggests that, despite previous experience, there is not a scintilla of doubt in the mind of Bernanke that this time QE will indeed work – and indeed will not be allowed to fail because the purchase of mortgage-backed bonds will continue until it does.

The timing of the Fed’s announcement – just two months ahead of a presidential election in which the economy is by far the dominant issue – cannot but invite accusations of political bias. It is an astonishing lifeline for the beleaguered President Obama and a frustrating tilting of the playing field against Romney’s Republicans. The announcement last week did not specify how long the $40bn pledge would be good for. But Bernanke’s term of office expires in January 2014 and Romney has made clear that a Republican administration would not renew his contract.

What effect might the Bernanke money-pumping have on our prospects here? UK companies with substantial operations in the US or exporting to the US should enjoy a pick-up in demand if “QE3” works in the way Bernanke desperately hopes. But there may also be a wider boost to business confidence from the determination of the world’s most powerful central bank to keep buying bonds until the continual drip-feed of the medicine shows some sign of working.

Certainly, an improvement in business confidence across the pond would almost certainly have spillover effects here. And, since it is rock-bottom confidence that accounts for our low business investment levels, this may well prove to be a case of “every little helps”.

Let’s hope this time that it works. When central banks turn on the spigots so forcefully, a continuing failure to bring a positive response would be truly worrying.

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