Closing bell: What comes around goes around as QE seems to pay off

BEFORE I went on a recent holiday to Florida, I picked up a wee story that has entertained more than a few people, but has given them a fresh angle on how to look at money or debt.

Subsequently, I discovered that people in Florida, indeed all over the United States, are as concerned as we are about debt and the stimulus package known as quantitative easing (QE).

This is how it goes: an ornithologist is down on his luck and in overdraft. However, he hears about a special eagle that's been seen in the Scottish Highlands and approaches his friendly bank manager (now there's a contradiction in terms) who agrees a further 100 to his overdraft to meet accommodation expenses.

So off our ornithologist goes. He finds a hotel in a wee village and he tells the proprietor about the special eagle that's nearby. He adds he would like to stay overnight, which would cost 100. However, he leaves the 100 with the hotelier on the agreement that if he cannot find the eagle, he won't be staying overnight and, therefore, would want the funds returned.

The hotelier knows about the eagle and assumes it's still around. As soon as the chap disappears, he nips off to the butcher to whom he owes 100 and pays his bill. The butcher then pops out to the local garage, where he has an outstanding bill of 100, and he repays it. The relieved garage owner now has 100 with which to pay money owed to Betty, a local artist.

When Betty's been repaid, she thinks it's time she paid off her debt to the hotelier who's been allowing her to use his facilities for an exhibition. The outstanding bill is 100.

Now that's been repaid, the hotelier has the 100 back when the ornithologist returns to let him know the eagle has gone and he won't be staying the night after all. He then goes back to the bank manager and returns the 100.

That proves you can take an imaginary amount of money, pay off lots of debt, and create liquidity at no cost. And it seems to me that's what's been happening all over the world with QE: you create money in some shape or form; you throw it into a system short of liquidity and the money velocity in turn solves problems.

I seem to remember that Steven Levitt, author of Freakonomics, believes money velocity works whether good or bad. Those of us that did economics or mathematics at school or college may remember the multiplier theory. It suggests if you spend a pound in the UK economy, by the time it's been re-spent by others it has seven to eight times the impact.

Levitt claimed that even bad spending by government, once it's been received by some recipient or other, is well spent as the multiplier takes over. So liquidity introduced into a monetary system has disproportionately positive impact. And, in the past, increasing levels of money supply pre-date economic growth and increased stock market returns.

WHEN in Florida, I discovered that the US isn't quite in the state painted by academic pessimists. US GDP growth is likely to confound most investors.

To my surprise, the GDP of Florida is the fourth-largest of any US state. In fact, it's one and a half times the size of Switzerland's and three-quarters that of Brazil's.

For those who see the US as a fading economic star, be aware that the combined GDP of five US states, including Florida, totals $5.5 trillion. That's 10 per cent greater than Japan's and 15 per cent bigger than China's. Food for thought.

• Alan Steel is chairman of Alan Steel Asset Management