US should refrain from launching QE3 and tighten its monetary policy to raise the world's confidence in the dollar.
In responding to the global financial crisis, many countries adopted extremely loose monetary policies. These policies were necessary to ease their immediate pains and address the global recession, but they have had undesirable consequences in the long run, and for some countries these have now become a pressing challenge.
For the past several years, the financial crisis and policy responses to it have cast long shadows over advanced economies. The overall deleveraging and structural adjustment is far from complete and the repair of private balance sheets still has a long way to go. Even worse, various governments' stimulus efforts to support their economies have resulted in historically large fiscal deficits.
Monetary policy is not a tool that can solve every problem. With recovery still sluggish in the United States and Europe, there are fears of high inflation, which could lead to stagflation. Global headline inflation has risen a full percentage point to 3.6 percent since April last year. The US' second round of quantitative easing (QE2) failed to stimulate investment as well as job creation.
Although the US debt ceiling was lifted, the country's credit rating was downgraded, triggering turmoil on the international markets. There is a real sense that a new crisis point is fast approaching.
It is a recognized structural problem of the global economy that US over-consumption has been a principal source of world demand. Restructuring the model requires the US to change its national savings, consumption and investment habits so that it doesn't rely too heavily on consumption and government spending.
However, the US is trying to sidestep this necessary restructuring. Initiating QE3 may boost the financial and commodity markets for a short time, but it will bring about new asset bubbles and stoke further inflationary expectation, which will create problems for their own and the emerging economies.
It will take time to rebalance the US trade position from deficit to balance, because the country must produce more than it consumes, which requires that the sum of private and public savings match its domestic investment. While the personal savings rate in the US has modestly increased after the crisis, this is just a start, moreover, the national fiscal deficit crisis has been under way, and the fiscal trajectory is unsustainable.
The labor market has suffered lasting structural damage, and slowing hiring contributes to the higher rate and longer period of unemployment. Moreover, long-term unemployment impairs labor force's skills and employability, given the US safety net is less generous than in Europe, the consequence of persistent joblessness will be harsher. But the US unemployment rate should not be regarded as a reason for launching QE3.
In an integrated global economy, no individual economy can be "decoupled".
China has already adopted a prudent monetary policy to address inflation, the main threat to its economy, driven mostly by food prices, in particular pork prices. However, it should be noted that the deep-rooted cause of the country's inflation also lies in structural problems. During the middle stage of industrialization, the price pressure of agricultural products, energy products, fundamental productive elements, such as land and the labor force, even real estate and other assets, will be a feature of our lives. Monetary policy is not enough to tackle these issues.
Rising prices are a big concern for many Chinese households, and finding ways and means to let average people enjoy a larger share of China's development fruit will present a big challenge. This transfer of income, along with narrowing the gap between the rich and the poor, means transferring economic gains from companies to consumers, cities to countryside, and savers to spenders.
The current situation is so complicated that it requires a flexible and effective response. Across the US, Europe and Asia, purchasing managers reported worryingly feeble activity in the manufacturing sector, with new orders shrinking. China's official purchasing managers' index (PMI) fell to a 29-month low of 50.7 in July, indicating that the Chinese economy is likely to weaken further. Also, the China PMI run by HSBC, which focuses more on SMEs, has already fallen below 50.
The latest GDP figure is for the large part the result of credit-led massive investment in the past two years, and the current worsening of the global economic environment could be reflected in China's economy in 2012 and beyond.
It is also worth mentioning that the ability to address the next crisis and next recession may be much weaker than a few years ago, for the government's fiscal policy and monetary policy appear to be reaching their limits.
Right now the global monetary and financial conditions remain unusually accommodative, so it is time to normalize monetary policy. For different countries, this means different things. The US should refrain from launching QE3 and tighten its monetary policy to raise the world's confidence in the value of the dollar. China should be ready to closely monitor the delayed effect of its monetary tightening and carefully assess the synthetic impacts of a comprehensive policy package on the economy.
Few people deny there are many uncertainties ahead, but one of certainties is that the global recovery will be slower than most expected.
There is no easy way out of the recession, and no painless solution to deal with the structural imbalances. Policymakers in both developed and developing countries must focus on structural reforms no matter how tight or loose the monetary policy is.
The pain of reform is immediate and the payoff in the future, but it is better to pay modest costs today, in order to avoid much larger costs tomorrow.
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