Put that thing away, Ben!

Before he became Fed Chairman, Ben Bernanke was recognised as an academic expert on the Great Depression. He famously noted that the modern-day Fed would always be able to prevent such a thing from ever happening again, because it could, if need be, drop money from a helicopter to stimulate demand. He thus acquired the sobriquet "Helicopter Ben", though in the rarefied world of the dealing rooms, it was common to hear a more technical expression: "Bernanke's chopper".

Ben may have been as surprised as anyone when the 2007-08 financial crisis gave him the opportunity to put these theoretical musings to the test, in the form of the $2 trillion quantitative easing (QE) programme. This week the Fed announced it would try to give the sluggish US economy a further boost through a second round of asset purchases, referred to as QE2, though this time the scale will be a lot smaller: about $600 billion between now and mid-2011, or about $75 billion a month.

The Fed's decision had been widely anticipated and had polarised opinion, among politicians and pundits as well as economists, even before it was announced. Bernanke took the unusual step of securing the front page of The Washington Post for an article explaining his rationale.

This may not have been the best idea, though Bernanke is certainly on solid ground when he describes the uninspiring state of the US economy:

"....we could hardly be satisfied. The Federal Reserve's objectives - its dual mandate, set by Congress - are to promote a high level of employment and low, stable inflation. Unfortunately, the job market remains quite weak; the national unemployment rate is nearly 10 percent, a large number of people can find only part-time work, and a substantial fraction of the unemployed have been out of work six months or longer. The heavy costs of unemployment include intense strains on family finances, more foreclosures and the loss of job skills".

However, he is far from convincing when he tries to make the case that more QE is the answer; and this claim, made just a day after the Fed made its announcement, is surely a huge mistake:

"This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action".

Yeah, well, that's what used to happen with the old "Greenspan put", Ben, and look how well that turned out. Also according to Ben,

"Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion".

Can anyone any longer seriously believe that the reason the US economy isn't growing is that there isn't enough money swilling around? There was no shortage of money in 2007, but that didn't prevent the financial crisis. Thanks to the first round of QE, there's a whole lot more money now, but it doesn't seem to be producing much traction, mainly because banks are still much too uncertain about asset values to step up lending to any meaningful degree. (The same, by the way, can be said of the UK, the other major economy to resort to QE since the financial crisis).

It's becoming clearer by the day that the main reason the first round of QE "worked" (the US economy has been growing again for more than a year) was not so much that it led to healthier financial markets as that it boosted confidence. In 2008 markets were pleading for something to be done, and QE was the right move; but with so many experts and market participants sceptical about what can be achieved this time, it's unlikely that QE2 will generate a lasting surge in confidence.

In the meantime, observers outside the US are becoming increasingly critical. In Toronto, the Globe and Mail bluntly observed last week that QE is "just another name for devaluation". Central banks in emerging economies are warning that the first round of QE has already produced a bubble in their markets (care to explain how that helped the US economy, Ben?) and are angry that the Fed is pressing ahead with more of the same.

Today Bank of England Governor Mervyn King announced that he will be keeping his own chopper sheathed for the time being. It may not be long before we are all wishing that Ben Bernanke had kept his under wraps too.