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'Dropping Dollars from a Helicopter'

Sunday, November 7, 2010

By Anthony Rowley

It's the economy, stupid. This seems to be the message that those who trashed the Democrats in this week's US mid-term elections seemed to be sending to president Barrack Obama and his allies.It is indeed the economy, but not in the way that many American voters appear to believe is the case.

If the Tea Party (a Mad Hatter-like group if ever there was one) is to be believed, what is wrong with the US economy now can all be laid at the door of Mr Obama and his "big government" policies. Cut government (and taxes) down to size and all will be well, many Republicans like to claim.

If only it were so easy. The reality is different, and a good deal more complex. What the US economy is suffering from is neither primarily big government nor high taxes but the aftermath of years,or decades, of living too high on the hog - and doing it on credit.

This is not a popular thing for politicians to say, and Republicans flushed with triumph from promising smaller government and an extension of Bush-era tax cuts are certainly not going to say so. But Mr Obama has little to lose, and perhaps respect to regain,by "telling it like it is."

What he needs to tell the great American public is that the US economy faces a long haul out of the pit that was dug for it by previous administrations, including former Federal Reserve chairman Alan Greenspan's famous "put" or proclivity for drowning the economy in liquidity.

Mr Greenspan's successor Ben Bernanke is trying to go one better and is 'dropping dollars from a helicopter' now. As strategist Christopher Wood at HongKong brokerage CLSA says, Bernanke 'will likely carry on with his mad experiment until he precipitates the collapse of the US dollar standard.'

But recession cannot easily be bought off, any more than a vicious hangover can be cured by taking the hair-of-the-dog treatment to an extreme by imbibing ever larger doses of the alcoholic beverage that caused the problem. This is the hard truth that Mr Obama needs to convey to Americans.

Perhaps the president should have gone along (as I did) to the Institute of International Finance annual meeting at the Ronald Reagan Centre in Washington one crisp Sunday morning last month to hear Bank of Japan governor Masaaki Shirakawa talk about what is in store for the US economy.

"We need to accept the fact," Mr Shirakawa told a packed auditorium, "that once a country experiences a bubble it will take a fairly long time to rise up from the bottom in the aftermath of [the bubble's] burst, and to restore full fledged recovery despite unprecedented policy efforts."

This is precisely the message that US voters do not wish to hear, and why they have instead listened to siren voices telling them that all that is needed to put America's economic ills to rights is a good dose of tax cuts and smaller government. Quack medicine if ever there was any.

Mr Shirakawa's message to the IIF meeting in Washington became even more chilling to those who are expecting a quick fix in the aftermath of a bubble burst on the scale that the US suffered following the Lehman shock in the autumn of 2008 and the subsequent economic recession.

Japan's experience shows, he said, "that an economy will be unable to achieve a strong recovery without resolving excesses accumulated during a bubble period." Those excesses are, of course, unsustainable levels of debt at the household, corporate or government level.

"If foreign countries mistakenly draw the most important policy lesson from Japan's experience [after the collapse of its bubble economy] as being a necessity for short-term stimulative policy measures, they will risk writing the wrong policy prescription," said Mr Shirakawa.

"We cannot rule out the possibility that the current unprecedented easy monetary policy in many advanced countries, if continued for an extended period of time, will produce unintended consequenes," the BoJ governor added. That was a classic piece of understatement.

CLSA's Mr Wood is blunter."The Fed’s attempt to combat a perceived problem of deflation will end up creating a far bigger problem - systemic risk posed by ratcheting up QE (quantitative easing)" he says. "This is why America will turn out to be a case of “Japan-heavy” not “Japan-lite”.

Mr Obama is certainly intelligent enough to understand this and a good enough communicator to be able to explain it in relatively simple terms to the American public. He migth say something like the following.

"My fellow Americans. We are in a hole economically and the fact is that we dug this hole for ourselves. We spent too much, using borrowed money, and we fell for all the lures that bankers offered us to borrow more. That's what securitisation and the sub-prime mortage crisis were all about.

"Once we got just too deep in debt and the music stopped, we looked for an easy way out of the mess - a quick fix. Your government is as much to blame as anyone in this. We spent a whole heap of money - your money - trying to buy off recesison with fiscal stimulus, and now the Fed is printing the stuff by the barrow load.

"But I have to level with you, my fellow Americans, it's not going to work. The government is as over-indebted now as we all are as private citizens. Cutting taxes will just invite default. And, unless we stop the Fed printing money like crazy, the dollar's not going to be worth the paper its printed on."

He might add that, "we've just got to work our way out of this the hard way - the Japanese way if you like - and accept a lower living standard while we pay down our individual and collective debts. You're going to like me even less than you appear to now for telling you this. But you've got to hear the truth."

Had he listed to other words spoken by the BOJ governor, President Obama might have foreseen the outcome of the mid term elections. "Without sufficient public understanding of the fact that we need a long time to complete balance sheet adjustment," said Mr Shirakawa, "the delay in macro-economic recovery is likely to provoke social discontent." Prescient words.

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