Posted by: Dirk | July 5, 2012

Bad news for the economy, good news for markets

The FT’s UK edition has this item on its frontpage now. I haven’t watched the clip, but the title ‘Bad news for the US economy could be good news for markets as it might spur QE3’ is quite stunning. It describes the major issue of our time: financial markets and the real economy can and do move in different directions.

Of course, this is all due to policy. QE is able to buy time as financial asset prices move up and balance sheets look healthier. However, the real economy does not change. QE alone is pure window dressing if nothing else is done to address the real problems in the economy: consumers are drowning in debt, unemployment is high. Aggregate demand from real estate activities has fallen, and has not been replaced by demand for something else. Hence, the economy suffers.

Two things are needed now: a quick fix to stabilize the economy, and then structural reforms to stop the economy from moving into depression territory. QE might be part of the first strategy, but then only because it buys time to enact reforms. The financial sector is still a mess, and the well-documented problems are not fixed.

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