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04 March 2013

What if Quantitative Easing does not work?

Only a few short weeks ago in Davos, the great and the good – or those who have styled themselves the great and the good – felt able to tell us the eurozone crisis was pretty much over, and that growth was only the blink of an eye away from returning to solve all our problems.

Today the misplaced nature of that confidence should be apparent to everybody, in the wake of an election in Italy where nearly 25% of the electorate chose not to vote at all, while another 25% voted for a movement whose principal rallying cries were contempt for established politicians and a referendum on membership of the euro. Furthermore, the unelected leader who had been imposed by the EU commissioners scored a truly dreadful result.

Beyond a hat-tip to the Italian people for daring to demonstrate that they believe their representatives should be elected and not imposed, I am not really going to look at the politics of this, but rather at the economic and financial implications.

Quantitative easing

Since the credit crisis exploded five or so years ago, virtually the only solution that has been offered by governments has been to crank the printing presses and produce rafts of new money as part of a process known as Quantitative Easing (QE).

The USA, Japan, the eurozone and the UK have all followed the same course of creating new money in the hope that it will stimulate economies.

The subtext, of course, is that creating new money also reduces the overall debt as a percentage of GDP, for which the politicians can claim success. The fact that it also effectively transfers the debt to the taxpayers by deflating the value of their savings seems to have been ignored.

But what if the first premise is wrong? What if the whole direction is false?

So far, despite what was said at Davos, the stimulus has not worked. The situation in the eurozone has not improved; Spain has truly horrendous youth unemployment, Greece has people starving in the streets looking for food handouts and Italy has now seemingly declared that it wants to be ungovernable.

Stimulus money has not surged through the global economy creating new demand for goods and services. It has instead flowed into solid goods, which offer greater security than currencies whose value is being deliberately debauched.

This is the rational choice for investors.

So the result of quantitative easing is to inflate the price of commodities, which surely puts a damper on consumption. If investors are pushing up the price of commodities, then consumers, whose disposable income is being constantly devalued, will have less ability to do what they are supposed to do and consume.

While China and the other BRICs start from a lower base and therefore have more of a cushion, it would be naïve to expect the "new" economies to drive the world immediately.

But naïve is probably the best word to use to describe a political class that, with generally extremely limited experience of anything but the comfortable hothouse of professional politics, fails to understand the wisdom of the rational investor.

What then for metals?

That leaves metal prices in a somewhat odd situation – buoyed by investment demand and yet seeing that very investment demand choking off consumption growth.

Of the base metals, copper is the best placed as it is the most favoured by the investment community, although it will always play second fiddle to gold in circumstances like these.

Basic agricultural products must surely be an attractive alternative, however. Whatever investment does to the price, it is difficult to see demand being choked off there.

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