So now we know what the second batch of quantitative easing (QE2) is really for. Federal Reserve chief Ben Bernanke hasn’t really been very forthcoming about his precise aims in buying yet more US government bonds with yet more phantom money.
But it seems his goal is simply to fund the US government’s future spending. With his plans to extend tax cuts from the George Bush era, and add some of his own, President Barack Obama has thrown any pretence of caution to the winds. Despite recent talk of budget reform, the US has no intention of becoming fiscally responsible. It doesn’t have to. Europe has embraced austerity because it’s been forced to by the markets battering its weaker members. But the US – although hugely indebted – still holds the world’s reserve currency. It can have its cake and eat it (for now at least). And if you’re going to be splurging money anyway, better it goes into the pockets of consumers in the form of tax cuts, than to investment banks, which just use it to swap assets between themselves and the central bank, and then pocket the profits as bonuses.
Of course this is bad news in the long run for the dollar. The US is on an entirely unsustainable trajectory, and the tax cuts are a pretty clear sign that its politicians have absolutely no intention of worrying about the deficit until the good times return (by which point, of course, any sense of urgency will have dissipated). But then, you can say that for almost every developed country in the world. Britain can’t afford its existing healthcare and pension promises. Nor can most of Europe, as Société Générale’s Dylan Grice has pointed out on a number of occasions. The only solution for most developed countries is to inflate their way out of trouble. That’s why you’ve got gold
as portfolio insurance, after all.
But in the short run, the dollar could well strengthen, particularly if investors start to believe in a US recovery. What does all this mean for markets? Stocks were ambivalent – rallying at first, then slipping as investors realised the tax cuts might mean the Fed would abstain from further money-printing. And it’s possible that fearful US consumers will save rather than spend the extra money they get, although I suspect they’re becoming bored with frugality by now. So what should investors do? As Henry Maxey of Ruffer pointed out in the magazine a few weeks ago, perhaps the best way to hedge your bets is to buy into a market that’s cheap (so shouldn’t fall too much in case of disappointments) and which would also do well from a stronger dollar – Japan.
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• Merryn Somerset Webb is away.