Quantative Easing vs Austerity - Which One Wins?

originally published on inteldaily.com November 2010

The recent decision by the US Federal Reserve to print an extra 600 billion dollars has sent shock waves through Europe and Asia. Meanwhile Ireland is set to slash 6 billion euro in its December budget – an attempt to reign in the national deficit. America’s quantative easing strategy strongly conflicts with Europe’s solution to deficit (austerity) and begs the question who is making the wrong decision, who is going to emerge the winner?

Common sense tells us that if you have been overspending the best course of action is to cut back on spending until it is below income level, which then give you some chance of paying off your debts. This approach is advocated in Europe and the Irish government is taking this route, albeit too little too late. Underestimating the extent of the shortfall has culminated in a likely tax and cuts bloodbath on December 7th, which could possibly have been avoided if the Irish government had acted more decisively earlier on to stop the rot.

The American solution of more borrowing and more QE is clearly madness, however as the largest market in the world, their decisions have repercussions for the world economy, especially as the dollar (for now) remains the world’s reserve currency. In effect the US fiscal approach is like a person in the back of a boat drilling holes while everyone else is busy bailing out the water with buckets! Unfortunately, not only is US policy making a bad situation worse but they also seem determined to undermine other nations’ attempt to solve the problem any other way. The US based ratings agencies (such as Standards & Poor and Moodys) clearly unfairly favour the USA which retains its AAA rating despite the fact that America is really bankrupt. Conversely both Greece and Iceland have been consistently downgraded (making further borrowing expensive) despite the fact that they are in arguably better or no worse shape than America.

If the US economy and the dollar collapse completely it will undoubtedly be due to a final acknowledgement of the failure to reverse decades of living on credit. The Emperor has had no clothes for quite some time but it has taken a long time for the world to notice that without hyperinflation America has no hope of ever repaying its debts. If US institutions were considered ‘too big to fail’ then how much more is the whole US economy a liability that could drag the whole global financial system with it?

If Europe, China and India were to disengage from America it would accelerate the US decline, but it might just prevent a systemic failure that affects everyone. If the rest of the World continues to lend to and trade heavily with America then it is almost guaranteed that there will eventually be a default or dollar collapse – either of which could ruin economies all over the world and cripple even the Chinese economy.

So long as the US Fed keeps belching out money and the US government keeps borrowing and spending like crazy there is not much Ireland (or any country) can do to prevent a disaster – all that can be done is to try to get one’s own house in order before the whole house of cards comes crashing down. Devaluing the dollar may make American goods cheaper but since most of the export market has already gone it will make little difference and only encourage a mass exodus. As more countries, corporates and individual investors become aware of the truly crushing American debt and deteriorating infrastructure the acceleration towards a US collapse can only increase. If a collapse happens any time soon then European austerity measures will seem trifling as everyone will lose – there are no winners in a race to the bottom.