Former US treasury secretary also says eurozone QE has come too late to lift the region off the reefs on its own.
By Ambrose Evans-Pritchard, in Davos
12:44PM GMT 22 Jan 2015
Analysts expect the US 'to embark on a sustained economic upswing in the coming quarters' Photo: AFP
The United States risks a deflationary spiral and a depression-trap that would engulf the world if the Federal Reserve tightens monetary policy too soon, a top panel of experts has warned.
"Deflation and secular stagnation are the threats of our time. The risks are enormously asymmetric," said Larry Summers, the former US Treasury Secretary.
"There is no confident basis for tightening. The Fed should not be fighting against inflation until it sees the whites of its eyes. That is a long way off," he said, speaking at the World Economic Forum in Davos.
Mr Summers said the world economy is entering treacherous waters as the US expansion enters its seventh year, reaching the typical life-expectancy of recoveries. "Nobody over the last fifty years, not the IMF, not the US Treasury, has predicted any of the recessions a year in advance, never."
When the recessions did strike, the US needed rate cuts of three or four percentage points on average to combat the downturn. This time the Fed has no such ammunition left. "Are we anywhere near the point when we have 3pc or 4pc running room to cut rates? This is why I am worried," he told a Bloomberg forum.
Any error at this critical juncture could set off a "spiral to deflation" that would be extremely hard to reverse. The US still faces an intractable unemployment crisis after a full six years of zero rates and quantitative easing, with very high jobless rates even among males aged 25-54 - the cohort usually keenest to work - and despite America's lean and efficient labour markets.
Mr Summers warned that this may be a harbinger of deeper trouble as technological leaps leave more and more people shut out of the work-force, and should be a cautionary warning to those in Europe who imagine that structural reforms alone will solve their unemployment crisis.
"If the US is in a bad place, we are short of any engine at the moment, so I hope you are wrong," said Christine Lagarde, the head of the International Monetary Fund.
Mrs Lagarde said the IMF expects the Fed to raise rates in the middle of the year, sooner than markets expect. "This is good news in and of itself, but the consequences are a different story: there will be spillovers. One thing for sure is that we are in uncharted territory," she said.
Worries about the underlying weakness of the US economy were echoed by Bridgewater's Ray Dalio, who said the "central bank supercycle" of ever-lower interest rates and ever-more debt creation has reached its limits. Interest rate spreads are already so compressed that the transmission mechanism of monetary policy has broken down. "We are in a deflationary set of circumstances. This is going to call into question the value of holding money. People may start putting it in their mattress."
Mr Dalio said the global economy is in a similar situation to the early Reagan-era from 1980-1985 when the dollar was surging, setting off a "short squeeze" for those lenders across the world who borrowed in dollars during the boom.
There is one big difference today, and that is what makes it so ominous. "Back then we could lower interest rates. If we hadn't done so, it would have been disastrous. We can't lower interest rates now," he said.
“We’re in a new era in which central banks have largely lost their power to ease. I worry about the downside because the downside will come,” he said.
Mr Dalio said Europe is already in such a desperate predicament that it may have to go beyond plain-vanilla QE and start printing money to fund government spending - what is known as "helicopter money" in financial argot. "Monetisation is a path to consider," he said.
“If the moderates of Europe do not get together and change things in a meaningful way, I believe there is a risk that the political extremists will be the biggest threat to the euro," he said.
Mr Summers said QE in Europe will not do any harm - and might help a little - but comes too late to lift the region off the reefs on its own. “I am all for European QE, but the risks of doing too little far exceed the risks of doing too much. It is a mistake to suppose it is a panacea or that it will be sufficient."
Any error at this critical juncture could set off a "spiral to deflation" that would be extremely hard to reverse. The US still faces an intractable unemployment crisis after a full six years of zero rates and quantitative easing, with very high jobless rates even among males aged 25-54 - the cohort usually keenest to work - and despite America's lean and efficient labour markets.
Mr Summers warned that this may be a harbinger of deeper trouble as technological leaps leave more and more people shut out of the work-force, and should be a cautionary warning to those in Europe who imagine that structural reforms alone will solve their unemployment crisis.
"If the US is in a bad place, we are short of any engine at the moment, so I hope you are wrong," said Christine Lagarde, the head of the International Monetary Fund.
Mrs Lagarde said the IMF expects the Fed to raise rates in the middle of the year, sooner than markets expect. "This is good news in and of itself, but the consequences are a different story: there will be spillovers. One thing for sure is that we are in uncharted territory," she said.
Worries about the underlying weakness of the US economy were echoed by Bridgewater's Ray Dalio, who said the "central bank supercycle" of ever-lower interest rates and ever-more debt creation has reached its limits. Interest rate spreads are already so compressed that the transmission mechanism of monetary policy has broken down. "We are in a deflationary set of circumstances. This is going to call into question the value of holding money. People may start putting it in their mattress."
Mr Dalio said the global economy is in a similar situation to the early Reagan-era from 1980-1985 when the dollar was surging, setting off a "short squeeze" for those lenders across the world who borrowed in dollars during the boom.
There is one big difference today, and that is what makes it so ominous. "Back then we could lower interest rates. If we hadn't done so, it would have been disastrous. We can't lower interest rates now," he said.
“We’re in a new era in which central banks have largely lost their power to ease. I worry about the downside because the downside will come,” he said.
Mr Dalio said Europe is already in such a desperate predicament that it may have to go beyond plain-vanilla QE and start printing money to fund government spending - what is known as "helicopter money" in financial argot. "Monetisation is a path to consider," he said.
“If the moderates of Europe do not get together and change things in a meaningful way, I believe there is a risk that the political extremists will be the biggest threat to the euro," he said.
Mr Summers said QE in Europe will not do any harm - and might help a little - but comes too late to lift the region off the reefs on its own. “I am all for European QE, but the risks of doing too little far exceed the risks of doing too much. It is a mistake to suppose it is a panacea or that it will be sufficient."
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