Cheap credit is a prelude to disaster

Desperate times call for desperate measures; and quantitative easing is a very desperate measure. To get its economy moving, the US Federal Reserve has cut interest rates to almost zero, making money cheaply available to stimulate consumer demand and encourage companies to invest. The past experiment, at best, yielded only limited results and the US economy remains fragile and in danger of dipping back into recession.

So now, the Reserve may resort to a second round of quantitative easing (QEII) — basically creating money ex nihilo (out of nothing) that can be used to further bolster the economy. But, a lot of the money that the Federal Reserve creates will find its way to emerging markets as investors seek better returns in countries with relatively strong economic growth and higher interest rates. This will boost their currencies and create dangerous local asset bubbles.

And, there is no guarantee that any of this will help the US economy. Cheap and easy credit was the cause of the financial crisis in the United States in the first place and the first rounds of quantitative easing have not worked as expected.

The Federal Reserve should be careful about pursuing failed policies that will put further pressure on the creaking international financial system.