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Quantitative Easing Won't Work, Another Nasty Surprise for the Stock Market

Economics / Quantitative Easing Mar 06, 2009 - 06:41 AM GMT

By: MoneyWeek


Best Financial Markets Analysis ArticleSo here we go. Into the great unknown.

The Bank of England has switched the printing presses on. The Government has effectively written itself a dirty great cheque to fund all the extra spending it's going to be doing over the next few years (for more on the details, see Why quantitative easing won't work ).

This is supposed to help the economy. So that'll be why stock markets around the world continued to plunge yesterday... 

We're not done with nasty surprises yet

I'm not going to go on about quantitative easing this morning – you can read all about it here: What is quantitative easing? But I don't think it'll work. The main aim of printing money is to give banks so much you force them to lend it. But will anyone actually want to borrow? With house prices collapsing and most people in fear for their jobs, why would anyone increase their debts just now?

So the economy will continue to correct. And that's just what it's doing. Stock markets had another bad day yesterday as investors keep groping towards the grim reality that we are nowhere near done with the nasty surprises yet.

Over here, insurer Aviva managed to terrify investors by cutting its dividend payment. Not because it cut it, you understand, but because it didn't scrap it altogether. The share price fell by about a third. Investors clearly think that Aviva is being over-optimistic about its future, particularly as peer Old Mutual recently ditched its own dividend to save cash.

The Telegraph reports that finance director Philip Scott fell back on that old bogeyman of the stock market – the hedge fund – accusing them of "deliberately shorting the shares". Not sure how you can accidentally short shares, but I'll leave that for a moment.

Mr Scott should watch what he says. In the recent past, those who have accused hedge funds of tearing down their share price (Lehman Brothers, HBOS) have had a habit of coming to sticky ends. And in both cases, any hedge funds smart enough to do so, were absolutely right to be shorting their shares.

The real problem, as Alistair Osborne points out in The Telegraph , is that "Aviva has paid a dividend it didn't have to, raising fresh questions about its solvency." The divi will cost £500m. That's a big chunk out of a capital surplus of £2bn. And given the state of the stock markets, that surplus could fall much further.

So it's little wonder investors decided to punish the insurer for not erring on the side of caution.

Meanwhile, on the other side of the Atlantic, solvency fears were a big issue too. Now car maker GM's auditors have warned that it the company's future is in "substantial doubt". GM is now sending begging letters to governments around the world, asking taxpayers to stump up to save it. Well, we've paid for the banking industry, so why not cars?

The car industry is actually a pretty good metaphor for the wider economy. There's the threat of a lot of short-term pain if a big car maker goes bust. That makes politicians scared. So they'll be tempted to pump the car maker up with borrowed money to get it over this recession. But that just extends the pain and saves up problems for the future. The zombie car maker will plod along inefficiently, sucking up resources (such as money and skilled people) that could be deployed more usefully elsewhere.

Recessions are painful - but they happen for a reason

Recessions happen for a reason. They're nature's way of telling you that you need to change what you're doing because it's not working anymore. Bankruptcies clear the system of all the bad investments that were made during the boom times.

But they're painful. And quantitative easing is the latest attempt by the government to prop up a zombie economy. It'll just extend the pain, and it will make it harder for us to make the changes we need to make to have a more resilient, efficient economy in future.

The bottom for stocks is still a long way off

But that's what's politically expedient, so the bail-outs will continue. And that's one reason why the bottom for stocks is still likely to be a long way off. There's too much by way of nasty surprises still out there. The insurance sector is a prime candidate for more shocks, for example, particularly if asset prices keep falling.

And if you look at it from a contrarian perspective, sentiment is actually still too buoyant in some ways. There are still plenty of pundits out there looking to call the bottom, or claim that anyone buying now will definitely do well over the next 10 years. In short, there's not quite enough despair out there yet.

By John Stepek for Money Morning , the free daily investment email from MoneyWeek magazine .

© 2009 Copyright Money Week - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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