QE 2 far?

It looks as if any day now, Fed Chairman Ben "Helicopter" Bernanke will announce another round of quantitative easing for the United States. If third quarter GDP data for the UK, due out this week, show a significant slowdown (consensus is 0.4%, after 1.2% growth in Q2), the Bank of England may well follow suit. For both countries, it's a risky choice.

The initial resort to QE (or printing money, as we'd call it if we were talking about the Bank of Zimbabwe) made a lot of sense. Economies around the world were teetering on the brink of depression. There was a compelling need to ensure that the whole world didn't tip into the same kind of stagnation that has bedevilled Japan since the 1990s.

Both the US and UK economies have been growing for the past several quarters, so something seems to have worked. It's just not clear that the "something" that got things moving again was QE. It may have boosted confidence by providing reassurance that governments and central banks still had a few tricks up their sleeves to head off a depression. However, it has done very little to restore the flow of credit to the private sector, which was the supposed object of the exercise.

The combination of near-zero interest rates and QE seems to have gifted banks with history's biggest ever example of the much-loved "carry trade". Banks are taking in money almost free from their depositors and investing it in riskless government debt, a nice little earner. As a result, bond yields in both the US and UK are heading ever lower, despite record levels of issuance as both countries run up massive fiscal deficits.

You can't really blame the banks, who have been getting mixed messages from governments. They have been sternly warned to strengthen their balance sheets (which forces them to earn a secure and steady income, and hence leads them to tighten credit criteria) at the same time as they have been urged to maintain and enhance lending in support of the economic recovery (which, even in the best of times, means taking risks). Given the continuing overhang from the borrowing binges of the past decade and the prevailing uncertainty over the duration of the economic recovery, it's no surprise that balance sheet rebuilding has been a greater priority than lending growth.

There can be no guarantee that QE2, in either the US or the UK, can break this cycle. (People are using the old Keynesian term "liquidity trap" to describe the situation. That's not strictly accurate: what we have here is a sort of evil postmodern version, with both fiscal and monetary policies looking tapped-out). It seems only too likely that the main (if not the only) consequence of further printing of money will be to drive government bonds even further into overbought territory. Ben Bernanke watched Alan Greenspan inflate three asset bubbles, eventually producing the dire consequences we are all too familiar with. He may well be about to trigger a first bubble of his very own.