Monday, 18 October 2010

Bad news is good news ... again

Why do I have this sense of deja vu? No, it's not because I am heading to the airport tomorrow for another conference in far-flung lands (the Central Bank of Chile is having what promises to be a good one). It's that strange sensation I get from seeing stock markets rallying hard because Bernanke and friends are promising us more quantitative easing. So let's get this right. QE 2 is being discussed because a) output growth is slowing b) unemployment is high c) the US housing market is in the doldrums d) which means that the banks will have even more problems in the future e) which all sums up to a good chance of deflation. One can debate whether more money printing by the Fed is the right answer. As for the wisdom of bidding up stocks... either it works, which means that we will have anaemic growth plus rising prices, and then we have to worry about inflation (which has traditionally been bad for stocks). Or it doesn't, and we are getting something between the Great Depression and the Japanese lost decades. Neither prospect seems much of a cause for cheer. Now, when was it when I saw this last? That's right, in the fall of 2007, when increasingly bad news led markets to expect interest rate cuts from the Fed. For a few months, the bad news was accumulating, and the markets continued to move higher. Back then, people had complete confidence in the Fed's powers to make any recession disappear in... and when people realized it wasn't quite true, things really collapsed hard. It made for a good show back then. Given how untested QE is compared to good old interest rate tools, I wouldn't be surprised if we get a rerun in a stockmarket near you before long...

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