[Smart Economy Reading] Bubble Economy Addicted to Quantitative Easing

Printing money breeds bubbles and prolonged stagnation…we must restore the market’s proper function

After the mid-1950s, Japan sustained rapid economic growth, and by the early 1980s its per capita gross domestic product (GDP) had surged to $10,300, close to the United States’ $12,900. The driving force behind this high growth was exports. Japan posted large trade surpluses through exports to the United States, and to preserve as much export profit as possible, it adopted a fixed exchange rate system. A fixed exchange rate system limits fluctuations in exchange rates, producing an effect similar to using a common currency in international transactions. In particular, it has the advantage of preventing exchange losses caused by differences in currency values during trade transactions. While Japan was earning handsome profits from exports to the United States, the U.S. manufacturing sector was dealt a severe blow by Japan’s low-priced products. In response, the United States, seeking countermeasures, devalued the dollar through the 1985 Plaza Accord.

As a result, within a single year the yen-dollar exchange rate was cut in half, and Japan’s export industries were hit with a brake as they could no longer export high-quality goods to the United States at low prices. They had lost export competitiveness because of the yen’s appreciation.

The asset “bubble” caused by interest rate cuts

Alarmed, the Japanese government implemented a policy of cutting interest rates. At the time, the government believed that lower interest rates would encourage companies to invest more aggressively in facilities and product development. In that way, it hoped to restore export competitiveness. But reality turned out differently. Once interest rates were lowered, people did not invest in the real economy; instead, they turned their attention to financial speculation in assets. One after another, people took on excessive loans to buy stocks and real estate, and this excessive investment created a price bubble, ultimately driving stock prices, housing prices, and land prices to several times their real value. As liquid capital concentrated in the real estate market, prices rose without end. The surge in real estate prices led to even more borrowing, inflating the bubble further.

In the early 1990s, Japan’s bubble economy finally collapsed. This was because the Japanese government raised interest rates in an attempt to restrain investment activity. At the time, it believed the economy had overheated because interest rates were too low, and it was confident that raising rates would easily solve the problem. But just as with the earlier rate cuts, the rate hike policy also produced results that shattered the government’s expectations. Starting with the rate increase, the bubble burst, and Japan’s economy entered an uncontrollable downward spiral. First the stock market collapsed, followed by a crash in the real estate market. During the bubble era, many of those who had recklessly borrowed to buy property took their own lives, and companies that had focused only on real estate investment rather than real investment went bankrupt one after another. Faced with this grim reality, Japanese society fell into despair, and the economy sank into the inescapable swamp of long-term stagnation.

Since COVID-19, many countries have been creating bubble economies through quantitative easing. They are intoxicated by the complacent belief that they can overcome crises simply by flooding the economy with money. At first, economic stimulus through quantitative easing appears to be successful. But the essence of quantitative easing is artificial government intervention in the market. We have already confirmed many times that artificial market intervention does not have a positive long-term effect on the market. The core of quantitative easing is that the central bank buys the bonds of troubled financial institutions and rescues them from the brink of collapse. This not only blocks rational restructuring by bailing out financial institutions’ insolvency with taxpayers’ money, but also risks encouraging moral hazard in the financial sector.

After the bubble bursts comes prolonged stagnation

Since the 2008 global financial crisis, the United States has maintained quantitative easing for far too long. In times of severe economic contraction, increasing the money supply in the short term is a necessary measure, but printing money to stimulate the economy is not only ineffective but also likely to produce side effects. A representative example is Japan’s prolonged slump after the collapse of its bubble economy. Unfortunately, bubbles already addicted to quantitative easing reveal themselves in the form of enormous debt. Following Japan, the fiscal conditions of many countries are deteriorating. Japan’s current debt situation is serious. It sought to stimulate the economy through negative interest rates and unlimited monetary easing, but the results were minimal. The “Lost Decade” became the “Lost 20 Years,” yet rather than escaping it, Japan is still struggling in an inescapable swamp of national debt, prolonged deflation, and trade balance deficits.

In addition, the bubble created by quantitative easing risks triggering crises in emerging economies. As dollars have been released without limit around the world through quantitative easing, investment has become more active in emerging economies. At times, this has even led to overheated investment. What will happen if those dollars are withdrawn again? Obviously, the financial markets of emerging economies will be severely shaken. And the rapidly rising external debt fueled by quantitative easing will come back like a boomerang, damaging fiscal soundness. This could lead to the worst-case scenario: a financial crisis originating in emerging economies.

We must not be misled by bubble economies addicted to quantitative easing. Rather than relying on artificial government intervention in the market, we must focus on restoring the inherent functions of the market economy. Instead of propping up the economy by force through quantitative easing, we should allow the market itself to revive the economy autonomously. Otherwise, the moment the bubble bursts, an even harsher and more dreadful economic crisis may come crashing down.

△ Please remember

Since COVID-19, many countries have been creating bubble economies through quantitative easing. In times of severe economic contraction, increasing the money supply in the short term is a necessary measure, but printing money to stimulate the economy is not only ineffective but also likely to produce side effects. Rather than artificial government intervention in the market, we must focus on restoring the inherent functions of the market economy. Instead of forcibly propping up the economy through quantitative easing, we should allow the market itself to revive the economy autonomously.

Sung-no Choi, President of the Center for Free Enterprise (CFE)

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Original title: [스마트 경제 읽기] 양적완화에 중독된 거품경제

Author: Sung-no Choi

Date: 2021-09-13

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=column&pn=4&idx=24249