A Close Eye On The Fed

When taken off life-support systems the patient begins to sink.” That analogy appropriately describes the health of the US economy. A slowdown happened after QE1 (the first quantitative easing programme) ended and it is happening again now as QE2 draws to a close (Q1 2011 GDP growth decelerated to 1.8 per cent, compared to 3.1 per cent in Q4 2010). Fed chairman Ben Bernanke has admitted to the worsening health of the economy. As economists scale down their GDP projections for the year, a debate has broken out in the US over whether there is a need to launch a third edition of the quantitative easing (QE3) programme.

No, they won’t One point of view is that the US economy’s slowdown is temporary, caused by disruptions in supply chains emanating from Japan, which led to suspension of operations in many factories. Since the slowdown is temporary, there will be no need for further support in the form of QE3 and the economy will start growing at a faster pace of its own accord.
The political climate today also does not favour QE3. The recession has ended and what the US now faces is a slow-growth scenario. When the situation was dire, support for the quantitative easing programmes was near unanimous (for lack of alternatives). But now questions are being raised about their efficacy: were they useful or did they just bring temporary relief and hence are not worth all the dollars spent on them? A viewpoint has gained ground (and rightly so) that the liquidity-injection programmes, instead of encouraging corporates and households to spend more, merely led to funds leaking out to emerging market equities and commodities, where they were deployed for speculative purposes.
With the Republicans gaining control of the House of Representatives and determined to rein in the deficit, expansionary fiscal measures are out of question. In such an environment, a move by the Fed to launch QE3 could also invite a political storm. Opposition within the FOMC (Federal Open Market Committee, the key policy making body within the Fed) to launching a QE3 has also strengthened, with many members worrying about the inflationary impact (May inflation figure came in at 3.6 per cent) of these liquidity-injection programmes.

Yes, they will, eventually The other point of view is that the Fed will eventually be forced into doing a QE3. The US economy, according to this viewpoint, is just too weak. A recovery will take years and not months. What the US is witnessing, according to this viewpoint, is a credit recession which is very different from an inventory recession (the normal crisis of over-production).
In earlier recessions, the Fed would lower interest rates following which the stock markets would receive a boost and house values would levitate. The resultant wealth effect would induce people to spend. They would borrow or take money out of their home equity to finance spending binges. The resultant demand would lift the economy out of recession.
But in today’s credit recession household balance sheets are in the red. Unemployment reins at around 9 per cent, causing immense anxiety about the future. The housing market remains in a slump. With households still trying to mend their balance sheets, theconventional tools like lowering interest rates and even unconventional ones like injecting liquidity into the system are proving futile and are not leading to revival of demand.
The proponents of this viewpoint say that even though political opposition to QE3 may be high currently, it won’t always be so. As time goes by and fears of a double-dip recession take hold, the cries to do something will get louder. Fed chairman Bernanke will then oblige with a QE3 programme.

Collateral damage Whether the US goes in for a QE3 programme is not of mere academic interest to us in India. QE1 and QE2 may have boosted our stock markets, but they also damaged our economic fundamentals by inducing worldwide commodity and oil price inflation. The high price of crude will exacerbate India’s current account deficit this year. High inflation is already hurting discretionary spending by consumers while squeezing corporate bottomlines. With business confidence slumping, corporates have postponed their capex programmes. This has led to a chicken-and-egg type of situation: unless corporates invest on expanding capacity, core (manufacturing) inflation will not ease. But unless inflation eases and business confidence improves, corporates will not undertake investment.
If there is no QE3, oil and commodity prices will ease (don’t expect a drastic correction), and that will bring much-needed relief to the Indian economy.

Keep your eyes on the Fed Keep a close eye on America’s quarterly GDP figure and on the Fed’s pronouncements. As things stand, it is difficult to believe that the US economy will return to a healthy growth rate (say, around 3 per cent) of its own accord. I feel the cookie will crumble within the next quarter or so and another bout of liquidity injection programme will be undertaken then (maybe in a slightly different form: now instead of buying bonds there is talk of directly injecting money into corporate capex to aid job revival).
If QE3 is of a sufficiently large magnitude (QE2 was a $600 billion programme), be prepared for the saga of liquidity-driven rallies in emerging market stocks and in commodities to repeat itself. The collateral damage in the form of high inflation will also recur.
Many emerging market governments and central banks have already demonstrated their willingness to impose capital controls. If the next round of dollar tsunami once again threatens to play havoc with our economic fundamentals, perhaps our own central bank will get pushed into contemplating something equally drastic.

Depend more on the info highway Make greater use of IT tools in this era of rising fuel and real estate costs
Despite the June 24 hike in the price of diesel, kerosene, and LPG, the under-recoveries of oil companies will be a hefty Rs 1,20,000 crore this year. We may well see more fuel price hikes in the near future, especially if crude remains at its current level or edges up further due to geopolitical factors. What is certain is that the era of cheap oil is over. Over the last 10 years, real estate prices have also appreciated sharply in our metropolises. For small and medium sized enterprises, setting up an office in the central areas of major cities has become impossible. They are forced to set them up in distant suburbs, which translates into long hours of travel for the workforce. The cost in terms of time, energy, and money is rising with each passing year. Meanwhile, telecom costs have been falling in our country. These emerging realities call for a realignment of the way we work.

For a considerable proportion of knowledge workers, shuttling everyday to office and back is now a redundant, industrial-era practice. IT tools make it possible to work and collaborate while staying put at home. Skype allows you to speak to your colleagues at minimal cost. Google Docs allows you to share and work simultaneously on the same documents.
In this mode of working, employees will have to learn to maintain meticulous records of daily output. Employers will have to learn to judge employees’ productivity based on these records (since visual evidence of their diligence will be unavailable). Coming to office could be reduced to only those days when there is a need — for major agenda-setting meetings or brainstorming sessions, or for work that requires office infrastructure. Employers could then make do with smaller but better-located offices. As with any other scarce resource, employees will have to call up in advance and book a seat or meeting room for themselves on the days they plan to attend office. While technology makes all this possible, it is our social forms of organisation that need to catch up.