The world's central banks are going to go on printing the money. I think we pretty much knew that already, but it has become even clearer in the past few days.
We have had a hint from Mervyn King of a further injection of cash into the British economy. We have seen the impact of the European Central Bank's €300bn credit line to Europe's banks on sovereign bond yields – basically, the banks can borrow for three years at 1 per cent and stuff the money into their home country's three-year debt at 3-5 per cent or more. Bit of a no-brainer, that one, for the banks, even if the policy was supposedly to support their lending to European industry, not to eurozone governments.
Most important of all, though, Ben Bernanke, the chairman of the Federal Reserve Board, has committed the Fed to continuing the present cheap money policy until the end of 2014. In money-market terms, that is just about forever. The yield on five-year US treasury notes last week dipped to 0.75 per cent.
It is a policy that can be justified in the short term, but which in the longer run make us all feel deeply uneasy. We are using the sort of extreme monetary measures that countries have in the past employed to finance wars merely to support a flagging world economy – or, rather, a flagging developed world economy, for the emerging markets are doing just fine. Thus, this is the first time ever in peacetime that the Bank of England has taken on to its books more than one-quarter of the national debt.
Now, one can justify this in the short term, though we should recognise that we should never have allowed ourselves to get into this position in the first place. The justification is twofold. First, that world output, particularly in the developed countries, is well below its sustainable capacity and that output is lost forever. Think of an airline seat or a hotel room. So it is right to use whatever tools we have to hand to try to nudge output up towards capacity. The main graph shows how even the emerging world is now dipping below capacity, whereas the developed world is slipping back even further.
Second, we cannot use fiscal policy, for everywhere in the developed world, including even the US, national debt is reaching a level where savers are starting to wonder whether they will get their money back. As a result, fiscal policy is being tightened just about everywhere, as the right-hand graph shows. Structural policies to try to increase growth are essential in the longer term, but they take years before they have much impact. So the tighter fiscal policy has to be offset by looser monetary policy. The orange bars on that graph have to be offset by the green bars.
But you will note something else. The offset in the developed markets is much smaller than the offset in the emerging markets. Monetary policy across the developed world is so loose already that it is hard to figure out how to loosen it still more. Here in Britain we will get another bout of QE, but given the somewhat muted effect of previous bouts, it is hard to see it setting the Thames on fire. On the other hand, the emerging countries have the leeway to ease policy, and that should help sustain demand in the year ahead. This will be yet another year of the two-speed recovery, with the emerging world leaping even further ahead of the rest of us.
That is the short term; what about the long?
Print a lot of money and it has to go somewhere. But it has not gone into inflation, or at least not that much, even in the UK. The easy money policy may have increased UK prices by, say, 2 per cent, small given the amount of the stuff printed. What easy money has done is boost asset prices.
Two examples of that. In the UK, the advent of QE was swiftly followed by a reversal of the decline in house prices. It did not lead to a huge boom, but it did at least put a floor on prices and as a result helped stabilise the economy. In the US, the main impact seems to have been on equity prices. Share prices on Wall Street have risen by 60 per cent since President Obama took office, an event that pretty much coincided with the easy money policy, though that had been established by his predecessor.
So what happens next? Well, I suppose that asset prices will continue to be supported by this policy for a while yet. The obvious question is: when will all this money find its way into current inflation?
No one can know. What I think we will see, though, will be some sort of turning point in sentiment over long yields. In other words, the fear of inflation will start to push up longer-term interest rates, even if inflation is not yet evident. The general perception of the markets is that this is still some way off, and further off as a result of the Fed's moves last week. I think that is probably right. But the further away the turning point, the more violent the reaction as and when it comes. That fits in with the general rule in financial markets: that things take longer to come to a head than you would expect, but when they do, everything happens more quickly. Apply that to the eurozone's long agony and you see what I mean.
There is a further issue. What are the long-term costs, aside from inflation, of having interest rates well below the rate of inflation? More bluntly, how long can you steal from savers?
Actually, quite a while, for there have been long periods in the past when inflation has gradually reduced the value of financial assets, particularly fixed interest ones. But the social costs are perhaps even greater than the economic costs, because sophisticated savers can take action to protect the real value of their assets. It is the unsophisticated who get hit hardest. That is not quite what central bankers like to acknowledge, but I fear it is true.
There is also an inter-generational effect, for older people tend to be savers, while younger ones are borrowers. Once voters come to realise that, the politics of easy money will change. There may, however, have to be some nasty moments on the way.
Smartphones reverse usual flow of ideas from developed to developing world
Did you know that China was now the world's largest market for mobile phones? Probably yes. And India number two? Yes again. But until I was looking at the data for this, last week, I had not realised that numbers four, five and six were: Brazil, Russia and Indonesia – the US is number three. So the Brics take four of the top five places on that particular league table, with Indonesia ahead of Japan. There are more mobiles in Pakistan than Germany, more in Nigeria and Mexico than Italy, and more in the Philippines than in the UK or France. What does this tell us, aside from that in this technology the emerging world has overtaken the developed world?
The first thing is that innovation in telephony – the application of smart phones to various tasks – will increasingly come from the emerging world. We are not used to that, for most new ideas that started out on computers (as opposed to mobile phones), such as Facebook and YouTube, came from the US. So the social impact of these came from the developed world. This will change as the smartphone becomes the focus of social innovation.
The second is that we should expect many more commercially successful ideas to come from the emerging world. China is shooting up the patents league tables, though the quality of many of the ideas is questionable. But the more successful the emerging world is at making money with the new technologies, the more that we in the West will look there for ideas.