Liquidity and economic recovery By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

October 23, 2015 | Posted by bobbysrinivasan << back to blog

The global economy is currently in immense danger of slipping into a major recession (the word recession is rather used to reflect a major slowdown in the economy). Japan has just announced that their second quarter 2015 GDP is negative. Eurozone has literally no growth rate to talk about. The monthly job creation in the US has dropped from the 200000 plus level to a lower 175000 plus level. China’s growth rate is faltering from a high of 7.5%. The Indian economy is expected to achieve an enviable 7.3% the only bright spot in the global scenario according to the IMF Chief Ms. Lagarde.

U.S., Britain, Japan and the Eurozone have all used quantitative easing (these countries did not use the same name for this action. Japan called it abenomics but the intention is the same). All there interest rates are near zero percent. Actually they have run out of the opportunity to lower the interest rates further since the rate of interest is nearing zero. This quantitative easing approach had pumped in several trillion US dollars in the global economy to create aggregate demand. For example, through quantitative easing (QE1, QE2, QE3) US pumped in 4 trillion US dollars. But as the latest data suggests the aggregate demand is not picking. The money is not going into the average consumers hand for them to spend. It is all rushing to create bubble in the stock and real estate market. Since the 2008-09 sub-prime crisis, all the global stock market have gone up substantially. For example the US Dow Jones index has literally doubled. The Indian Sensex recovered from 8000 to 27000 today. Did the adequate money go in to consumption and investment to push up the global GDP? The answer is no. What will happen if further pumping of the prime does not take place? This will create immense volatility in the stock markets finally leading to a serious crash like the 2008.

Historically when money is pumped into the economy it went into both consumption and investment. But this time around it is not going there. Instead it has gone into speculation of the existing asset prices. Clearly at this juncture pumping more money to revive economies will end up only as misadventure. It will go to build up further speculation in the stock market and possibility real estate.

This brings us to the question of what is liquidity. How much should be adequate? How do we ensure that this money reaches productive rather than speculative activities? Dr. Raghuram Rajan of RBI recently lowered the repo rate by 50 basis points. No commercial banks have passed on the complete benefit to its customers. For example SBI announced that it will lower its flat rate by 40 basis points; why not 50 basis points? But look at the Indian stock indices it has moved from around 25000 to 27000 today. It is not easy to verify whether a significant part of the money moved into the stock market. But if did, the funds were used for speculation and not to spur the demand.

Finally, the US is courting a global disaster, because of excess pumping. The total indebtedness has reached 56 trillion US dollar (this includes government, corporate and individual debt). Credit is addictive. The bigger it gets, the chance of a major collapse is a possibility. So pumping liquidity does not necessarily guarantee an economic recovery.

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