SO here we go again. It is Monday morning, the news from Greece is bad again (the country is going to miss its 2011 deficit target), there are more worries about European banks and equity markets are falling sharply (the Dax is currently more than 3% down).

The echoes of 2008 seem to be getting louder. We have a debate over whether to mount a financial rescue with a dispute between those who worry about moral hazard and those who fear the consequences of a bankruptcy. Greece has just been substituted for Lehman in this equation. One solution is for a massive transfer of funds from northern Europe to the south but politicians in the former region fear this will be about as popular as the bank bailout proved with US voters. So they are pursuing other technocratic options to prop up the system. One is to use the democratically unaccountable vehicle of the central bank; to have the ECB buy unlimited amounts of government bonds (just as the Fed pursued two rounds of QE). The second is to gear up the European Financial Stability Facility and have it buy the bonds; there is a nice piece by Wolfgang Munchau in the FT today comparing this with the subprime CDOs of ill-repute.

These approaches are, of course, another way of transferring debt up the chain, since northern European governments stand behind both the ECB and the EFSF. This is still "the bailout that dare not speak its name". And it is the end of a long process under which debtors (originally US homeowners) failed to repay their debts threatening the solvency of banks, which had to be rescued by governments, some of which had their own solvency threatened, necessitating their rescue by bigger governments.

In my view, we are in a worse mess because both the fiscal and monetary authorities have used so much ammunition. Some countries can no longer expand their fiscal deficits because of market pressure; others (the US and Germany) face no market pressure but lack the political will to stimulate again. Interest rate are as low as they can go, except in the ECB where they could be cut a bit; but inflation is above target in the euro-zone (a surprise 3% number was released on Friday). So that is why the debate has got back to QE, it is the last game in town.

In a forum on Friday. I was asked what I would do about this mess, rather than offer a counsel of despair. My starting point is that QE allows governments to finance their deficits on the cheap by having the central banks create "free" money; money that is then pumped into asset prices. But let us link that solution to another problem; that of unstable markets and the domination of our economies by finance. In Dani Rodrik's  excellent book The Globalization Paradox: Why Global Markets, States and Democracy Can't Coexist, he writes of traders that

What do all these men in their twenties and thirties sitting in front of huge computer screens, who move hundreds of millions of dollars across the globe at a keystroke and determine the fate of nations' currencies really do? Do they serve to eliminate inefficiencies in the market and bring currency values close to their true underlying economic worth? Or do they magnify the ups and down is the market by acting like a herd and chasing phantom profits?

One answer to the second point might be given by those who think like Alan Greenspan; if the profits are phantom, surely the banks would have given up by now? They haven't given up because central banks have always bailed out markets, cutting rates whenever they falter. QE is just a continuation of this policy.

If we are going to hand out free money why give it to the asset markets? It seems at best a very roundabout way of tackling unemployment. We could give, say $20,000 to every business that gave an annual contract to someone from the long-term unemployed register. We could upgrade the tube system in London, which would surely enhance productivity (and human welfare).

Maybe none of this will work and a period of stagnation is inevitable. But if we are going for a "hail Mary" attempt to solve the crisis, let's spend the money on things that actually might help the economy in the long run.

UPDATE: On the chain of causality between QE, banks, asset markets and financialisation, this is a shortish blog post and I didn't want to repeat myself too much from previous efforts. But as the issue has been raised by human child, here goes. We have to explain a strange post-1980 phenomenon; banking and fund management, previously thought of as rather dull professions, suddenly saw their relative wages rise, vis-a-vis other jobs with similar qualifications, and their relative share of the economy grow. Why was this? Two crucial things occurred in the 1971-1981 period. First, the Bretton Woods system of fixed exchange rates broke down and then the financial markets were liberalised. The second followed the first since capital controls were at the heart of the Bretton Woods model (which produced a very impressive growth record, greater than that seen post-1971). 

The finance sector profited in several ways from this change. As capital flowed round the world, there was more trading, boosting commission income and that from buy-sell spreads. Secondly, lending volumes rose and with only mild recessions, bad debt problems were limited. Third, much of this lending was against assets, which rose in price. Two sectors that were previously quite small, private equity and hedge funds, that combined leverage and asset markets expanded massively, creating a whole bunch of billionaires.

All this, as Hyman Minsky analysed, created a potentially destructive cycle. A long period of stability encouraged speculation. Central banks worried about the potential for high debts to cause a financial panic (and 1930s style debt deflation). so they intervened at times of market panic. This Greenspan put merely seemed to give traders a one-way bet and encourage more speculation. Hence we had a series of bubbles that we didn't see under Bretton Woods (emerging markets, dotcom stocks, housing). That is the process of which QE is a continuation, and indeed Ben Bernanke cited higher equity prices as an example of the policy's success. We also saw the creation of giant banks that were too big to fail, something that must surely strike everyone as a problem, with the attendant combination of profits that accrue to the private sector in the good times and losses that accrue to taxpayers in the bad times.

But if the point of QE is to lower yields, the sharpest fall has been in the last few months, after the policy stopped! And it doesn't seem to have encouraged more lending by business, which was presumably the point. Nor has the wealth effect worked in boosting the single most important asset price for US consumers - housing. That is why trying another tactic seems worthy of consideration.