The Jackson Hole conference starting today is expected to include a talk by Ben Bernanke on the benefits and costs of further monetary easing, which in ZIRP-land means quantitative easing. Gavyn Davies put up a good short list of arguments made against QE at the Financial Times, and most do not look terribly persuasive. One which I found interesting was:
“QE will weaken the Fed’s balance sheet, and undermine confidence in the institution.” This was a very powerful argument in Japan in the 1990s, which reduced the amount of quantitative easing which the BoJ was willing to undertake. If the Fed simply buys Treasuries, it is hard to see how this weakens the balance sheet, unless you believe that the US government could default on its debt. However, if the Fed were to buy private sector assets, like securitised debt and/or equities, then it could subsequently have to take mark-downs on these assets, and many people would see this as a problem. But the Fed probably should not be treated like a private bank, which would suffer a loss of solvency if it suffers a mark-down on its assets. The Fed does not have to mark-to-market like a private bank. And, anyway, does it ultimately matter if the Fed has a negative net worth? The answer would be yes if it undermines the public’s faith in the institution, causing people to reduce their holdings of dollars, in exchange for goods, or foreign currencies. But this is just another way of saying that there is an inflation constraint on the Fed’s ability to increase QE, which everyone would accept. So the balance sheet argument only holds as a special case of the inflation argument.
I think Davies is missing a part of the dynamic here. The intensity of the battle over Bernanke’s reappointment and the partial victory for the Audit the Fed movement are tangible signs that the Fed’s aggressive action during the crisis has led to a hard pushback from Congress. Part of it may be deserved loss of faith in an organization that utterly failed to see the crisis coming and refused to exercise any control over banks; another may be that Congress recognizes full well that the Fed was acting as an extralegal, off-balance-sheet funding vehicle for the Treasury, meaning a route for circumventing normal budgetary processes. So if the Fed were to balloon its balance sheet to, say, $5 trillion, my sense is that there would be enough concern about the scale of Fed operations, particularly if the problem is a lingering economic malaise rather than a crisis, to produce concern in some quarters and lead to Congressional prodding (recall, by contrast, that the 2009 QE was implemented when banks still were on the ropes). So the fear of political action may also be playing into how the Fed views this issue.
The problem (which many economists and analysts will readily acknowledge) is that QE is being used as a stand in for fiscal policy, and it is a not so hot second best in an economy where firepower was already deployed to spare banks pain and prop up asset values. And in the US, stimulus was not well targeted, in addition to being half-hearted.
George Magnus of UBS, in Thursday’s Financial Times, made a lesser of two evils argument in favor of QE:
Better, if necessary, to print money and be damned, rather than tighten policy and be damned. Under the former, there is always redemption by withdrawing the stimulus if circumstances warrant. Under the latter, there is only chaos.
While I am not unsympathetic toward the case for QE, I think Davis made the most potent argument at the top of his post:
“Quantitative easing was tried in 2008/09, and it did not work.” True, the Fed expanded the size of its balance sheet by about $1.5 trillion dollars in a matter of a few weeks in 2008, so QE was certainly tried. We do not know what would have happened if this had not been done, but there seems a strong chance that the banking collapse would have been worse, and the economic recession much deeper, without QE. In that sense, the policy ”worked”, but the cure does not seem to have been permanent. It is hard to isolate the real reason for this. It may be because QE is an ineffective policy tool, or it may be because not enough of it has yet been done. Take your pick.
This is narrowly true, but misses the point. When an economy is very slack, cheaper money is not going to induce much in the way of real economy activity.
Unless you are a financial firm, the level of interest rates is a secondary or tertiary consideration in your decision to borrow. You will be interested in borrowing only if you first, perceive a business need (usually an opportunity). The next question is whether it can be addressed profitably, and the cost of funds is almost always not a significant % of total project costs (although availability of funding can be a big constraint).
And even more important, to the extent money costs matter, the relationship between price and activity is asymetrical. Too costly funding can kill a project. But cheap money (except for scamsters) is not going to make a businessman wake up and say, “Gee, my borrowing rate has fallen 2% in the last six months. I really should go out an open an new store.” He’ll do that ONLY if money being 2% higher was a binding constraint. The prospects for his business are always a first order consideration, the cost of money second order.
So the state of demand in his market is a major consideration, and for most businesses, that’s a function of the health of the overall economy. Most businesses see lousy conditions and surveys of small businesses (which employ over half the people in the US) show them expecting their businesses to face even more difficult conditions in a year. Various bank surveys similarly show weak demand for business loans.
So cheaper money will operate primarily via their impact on asset values. That of course helps financial firms, and perhaps the Fed hopes the wealth effect will induce more spending. But that’s been the movie of the last 20+ years, and Japan pre its crisis, of having the officialdom rely on asset price inflation to induce more consumer spending, and we know how both ended.
Einstein defined insanity as doing the same thing over and over again and expecting different results. And to me, the most compelling reason to be against QE is that policymakers will nevertheless hope it might be effective if used again. They will therefore refrain from trying more politically difficult, but more promising course, namely, restructuring debts and using government spending to cushion the impact, with a keen focus on measures that will restore competitiveness and reduce our trade deficit.
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Moin from Germany,
Hussman sums it up……
http://www.hussmanfunds.com/wmc/wmc100823.htm
My impression is that Ben Bernanke has little sense of the damage he is about to provoke. A central banker who talks about throwing money from helicopters is not only arrogant but foolish.
Nearly a century ago, the great economist Ludwig von Mises observed that massive central bank easing is invariably a form of cowardice that attempts to avoid the need to restructure debt or correct fiscal deficits, avoiding wiser but more difficult choices by instead destroying the value of the currency
Thanks for that simple truth, which is at the heart of the decline we observe. Decades of this cowardice has led us to ever starker choices.
Likely this will continue until Helicopter Ben and his ilk have destroyed the full faith and credit of the US.
Have any other prominent bloggers or economists commented on Hussman’s prediction? It’s stark & unequivocal.
Sorry, I don’t have time to get into the substance of Hussman’s post, but like most every stark and unequivocal prediction, it is almost certainly wrong. We live in a world with a chaotic economy that has positive feedback loops and not just unknown measurements but unknown variables that we don’t even think to try to measure. One may be able to predict with certainty that if one loads a gun, points it at a person’s head and shoots, one will likely kill the other person. As to more complicated things like the future of a currency used in trillions of transactions by hundreds of millions of citizens and foreign entities over decades, sorry, Hussman can’t predict the future and neither can anyone else. Yes, if QE includes the printing of tens of trillions of dollars, the currency will collapse. Where one crosses the line with QE, no one knows. It’s lunacy, really, but I’m trying to avoid being too derogatory.
Hussman doesn’t understand the Fed’s recent announcement and implementation of ‘QE Lite’.
From his first paragraph Hussman says the Fed will be “paying for those securities by creating billions of dollars in new monetary base”. Not true.
The Fed is taking the existing money that was created by QE 1.0 that will otherwise vanish as MBS already on the Fed’s balance sheet mature, and using those funds to purchase Treasuries.
In short, the Fed is trying to maintain the current size of its balance sheet constant. It doesn’t want it to shrink or grow.
http://www.guardian.co.uk/business/2010/aug/10/federal-reserve-supports-us-recovery
Hussman also says “Why quantitative easing is likely to trigger a collapse of the U.S. dollar”. The Fed has already engaged in over $1 trillion in QE and the dollar hasn’t collapsed. Either Hussman is being imprecise with his words (e.g., he should have said ‘Why “new” quantitative easing is likely to trigger a collapse of the U.S. dollar) or he’s ignoring facts.
I’m deeply concerned about QE and further QE, but Hussman is either being sloppy with his words or doesn’t have a grip on the facts.
Thanks to PolyCap & AnJo.
jmf, you are right on your assessment. What is it that makes him so blind? Bernanke needs to take a step back to truly evalutate the effect. What is happenning with the rest of his team? There is nothing to gain but the contrary
Until the elections, and probably until well after the elections, the US Congress is paralyzed. This will not change until conditions deteriorate significantly (higher unemployment, crashing markets, or social unrest).
That leaves one adult in the house: The Fed. Regardless of how they’ve f*&(*d things up historically, what are they to do now, just sit on their hands, wait for the political crisis, and for Congress to act? That could be months or years away, and by that time things could get dramatically uglier.
I think the Fed would like both a lower dollar and higher inflation. One way to do this (if Hussman is right) is QE. It may not be the best solution, but we are out of perfect solutions, and pace Voltaire, even good ones. I don’t mean to exculpate the Fed; but with Congress paralyzed, the options are precious few.
I think this is the real issue. While I have serious issues with Bernanke this is really cowardly abdication on the part of Congress. The Fed has a key role to play but not the leading role; it is not the right tool for the job but the only one willing to act. What the Fed can do only goes so far, and even if Bernanke were a genius its actions would fail. Grown up fiscal and economic policies and requiring accountability of the fraudulent are required — fortunately we have an agency responsible for those things, unfortunately it’s called Congress. And what has to be done is either politically scary or terminal to their chances of landing a lobbying or board position. Much easier to point fingers or hold up shiny objects.
Really excellent post.
‘So cheaper money will operate primarily via [its] impact on asset values. That of course helps financial firms, and perhaps the Fed hopes the wealth effect will induce more spending.’
Yep, that’s their logic. But it’s full of holes. The main asset being driven up is bonds, particularly Treasuries. With the Fed committed to buying more T-notes, everyone from Wall Street to individual mutual fund punters is front-running them, producing an historic surge into bond funds.
But with lending stagnant, falling yields produce a negative wealth effect. Consumers cannot obtain acceptable yields anymore from traditional low-risk vehicles such as savings accounts, CDs, and T-bills. Some have gone to speculating. When they purchase emerging market funds, the stimulus leaks overseas. Others will just hold cash in disgust.
However, there’s a second, uglier negative wealth effect: Depression-like yields are scaring the wits out of people. The more Treasuries Bernanke buys, the worse it gets. Consumers are responding by cutting discretionary purchases and saving more. This is the classic macroeconomic recipe for self-feeding depression, which motivated Keynes to urge fiscal stimulus. Check out this appalling chart of the Consumer Metrics Institute growth index, which leads GDP and has plunged back to late 2008 levels:
http://dshort.com/charts/Consumer-Metrics-GI-GDP-SPX.gif
For now, fiscal policy is frozen. ‘QE 1.5’ is actually backfiring badly, spreading a tomb-like chill over the collective consciousness.
Strangely, no one talks about the third lever for easing financial conditions — currency depreciation. It’s worked wonders for Germany. But although US officials harangue China to let the renminbi appreciate, Treasury hasn’t actually intervened in forex since Sep. 2000, when it joined an international campaign to prop the euro from falling below 85 cents.
If the US wants to extricate itself from deflation and the dreaded zero bound, it’s got to take proactive steps to weaken the dollar. QE II is the wrong way to go about it, as falling yields reinforce deflationary expectations. I will have more to say about this after reviewing Bernanke’s remarks.
If we’re talking about “the classic macroeconomic recipe for self-feeding depression”, then currency depreciation has to figure prominently. This is precisely what Roosevelt did in ’33 and certainly did not end the depression. Like all policies that crucify the responsible for the sake of the spendthrift, it is at best an example of one-hand-giveth-the-other-taketh-away, as the reduced debt burden is necessarily offset by the destruction of capital. At worst, it is a direct subsidy of everything that caused the crisis in the first place. Such measures may buy you a year or two of better numbers, but they are only destructive economically and no recovery can come from them — and cretainly in the 30’s none did.
Furthermore, even though your intention is to inflate away debts, other nations will not see currency devaluation in such a benign light. They will call it “beggar they neighbor” and respond appropriately. And with massive dollar holdings in foreign countries, our ability to control our own currency is suspect; depreciation could easily spin out of control if it persuades these holders to dump.
Finally, since there is no gold to confiscate, and the possibility of accomplishing this depreciation overnight is virtually nill, there is the question of how on earth you would persuade banks to accept government paper that is guaranteed – in fact, intended – to lose much of its value.
—
We cannot liquidate the debt without incurring deflation, and deflation would ignite decades-worth of economic detritus that inflation, credit growth and subsides have effectively hidden. However liquidation is the ONLY option for reversing, and not merely delaying, the course of the disease. Statism is no solution; tumors do not make truces. Japan is creaking under the weight of them, and it appears that we are eager to follow their lead.
the reduced debt burden is necessarily offset by the destruction of capital.
All capital… or just hoarded money? A productive asset (a factory, a farm, a portfolio of patents, a commodity) is still potentially useful, regardless of what the dollar is doing.
And wouldn’t the reduced debt burden increase demand, and therefore production?
“All capital… or just hoarded money? A productive asset (a factory, a farm, a portfolio of patents, a commodity) is still potentially useful, regardless of what the dollar is doing.”
By definition, no. It is capital that has been lent out that is destroyed by currency depreciation. This is why assets are “hoarded” in the first place. When the government pursues an inflationary course of action, currency and currency-denominated debt no longer serve as a store of value.
Ownership matters. Productive assets are, first of all, nondurable goods in the long run and need to be rebuilt. They are, secondly, often capable of accomplishing a variety of functions. The life and productivity of such assets, and their renewal, depends greatly upon who owns them. Additionally, and you should know this intuitively, the violation of ownership has grave consequences. Wealth will disappear overnight if people perceive that it is liable to be stolen.
And finally no, demand will not necessarily increase. Institutions and individuals who counted upon future income from debt repayments will now need to repair the damage by spending less now. If you at all increase general demand, it is only at the expense of capital. The government can assume the loss, but this merely delays the necessary process of re-capitalization.
By definition, no. It is capital that has been lent out that is destroyed by currency depreciation. This is why assets are “hoarded” in the first place. When the government pursues an inflationary course of action, currency and currency-denominated debt no longer serve as a store of value.
So: Capital has been lent out (i.e. “someone’s debt”), which exists as a store of value for… someone else. Inflation would threaten this ‘store of value’ (i.e. expected future debt repayments), which would be bad because this would discourage that ‘someone else’ from… continuing to use other’s debt to store their value (i.e. from creating more ‘wealth’ in the form of debt).
Shorter: “We can’t threaten current debts with inflation, or it will threaten the future creation of debt!”
Ownership matters. Productive assets are, first of all, nondurable goods in the long run and need to be rebuilt.
…which in and of itself is a form of consumption, which employs people and in turn creates some level of demand. All very good things. As opposed to non-productive assets (say, for example: expected future returns on non-productive –in fact, parasitic– debt).
You’re assuming (or pretending) that all ‘Capital’ is equivalent, but it’s not.
“Shorter: “We can’t threaten current debts with inflation, or it will threaten the future creation of debt!””
More or less. Despite your snarl, there is nothing intrinsically wrong with debt.
“…which in and of itself is a form of consumption, which employs people and in turn creates some level of demand. All very good things. As opposed to non-productive assets (say, for example: expected future returns on non-productive –in fact, parasitic– debt).”
This response is rather nonsensical. You do not understand what I said. In any event, the productivity of debt is decided case by case, and your generalizations are meaningless. Please spare me the foray into class morality.
‘it is a direct subsidy of everything that caused the crisis in the first place’
Just the opposite. It was the subsidy of an overvalued dollar that helped lead to the crisis.
‘in the 30’s none did’
In the 1930’s the situation was the exact opposite – the US was the world’s largest international creditor instead of the world’s largest international debtor.
‘They will call it “beggar they neighbor” and respond appropriately.’
Sure, and a bank robber can call himself a victim, but that doesn’t make it so. China and numerous other foreign countries are the ones that have had beggar-thy-neighbor policies for years. That’s objective fact, as substantiated by years of trade statistics.
‘there is the question of how on earth you would persuade banks to accept government paper that is guaranteed – in fact, intended – to lose much of its value’
Which banks? You’re confusing exchange devaluation with domestic inflation. Ironic, given that Jim Haygood is arguing against the very policy (QE) who’s primary effect might be the inflation you fear.
‘Statism is no solution’
So you should be particularly opposed to the Chinese statism that causes our overvalued dollar.
I don’t disagree, and yes I was focusing on domestic inflation. However the two are not separable.
The strong dollar involves more than ourselves and China. But let’s focus on that. In the course of its manipulations, China has effectively sequestered a great deal of our currency. Devaluation will either involve, or necessitate, their selling of treasuries. They will not sit idly while we depreciate the asset side of their central bank’s balance sheet. The move towards home currencies and the reintroduction of treasuries into the market WILL generate inflation. That it was deferred inflation from this past decade and the 90’s, only means that consumers will be faced with rising prices without the benefit of any new spending power.
Yes the situation with China must be resolved. No, it will not “ease” our financial condition.
“They will not sit idly while we depreciate the asset side of their central bank’s balance sheet.”
China has pursued their current strategy knowing full well that a devaluation of their dollar holdings will ultimately and inevitably occur. The Chinese government may be many things, but they’re not stupid.
Not to say that China will go willingly – that’s why a tariff threat is necessary to get them to move.
“The move towards home currencies and the reintroduction of treasuries into the market WILL generate inflation. That it was deferred inflation from this past decade and the 90’s, only means that consumers will be faced with rising prices without the benefit of any new spending power.”
True, but we agree that it was deferred inflation. Time to pay the piper.
“Yes the situation with China must be resolved. No, it will not ‘ease’ our financial condition.”
The worst part of our financial condition is high unemployment and lack of productive investment opportunity. A lower dollar will help fix that with increased exports and/or import substitution. As a net saver I’m not thrilled about the inevitable inflation, but long term unemployment is even worse.
On the bright side China and other countries are not going to let the dollar crash, as that would make things even worse for them. Hence we shouldn’t see rampant inflation, any more than we did after the Plaza Accord in 1985.
‘If we’re talking about “the classic macroeconomic recipe for self-feeding depression”, then currency depreciation has to figure prominently. This is precisely what Roosevelt did in ‘33 and certainly did not end the depression.’
Perhaps you’d care to review the NBER’s business cycle dates, which show an expansion from March 1933 to May 1937. The dollar’s devaluation against gold occurred during the first 18 months of the expansion. Just the facts, ma’am.
http://www.nber.org/cycles/cyclesmain.html
Other nations which devalued before the US (i.e. the UK, which unpegged from gold in 1931) suffered shallower troughs than the US did.
Asian nations, almost across the board, maintain undervalued currencies. They do it for a simple reason — it works.
Perhaps you’d care to review the debt levels (all US credit) for the mid-30’s, which ballooned from approximately 160% of GDP in 1932 to a peak of 260% in 1936, then fell almost as precipitously. That “expansion”, much like the housing boom of recent years, was entirely bought by a cocktail of increased debt and inflation. As I said, you might buy a year or two of better numbers… and you’re a fool if you believe those numbers.
The Asian model works? I suppose if your standards are particularly myopic, then yes you could say that. China has built its entire economy upon an eroding beachhead, because the real estate was cheap. A time will soon come when the Chinese model, like the Japanese model before it, does “not work”; and it will not work so spectacularly that folks who made such facile judgments about the matter will begin to feel decidedly “not smart”.
Yeesh. If I jumped from a cliff and flapped my arms, you’d be right behind Paul Krugman in saying “he’s flying!”.
My figures vis a vis the depression are wrong. I’ll have another go at this later if I get a chance.
Jim Haygood: “Strangely, no one talks about the third lever for easing financial conditions — currency depreciation.”
Hear, hear!
I’m not sure I agree that QE is actually harmful, at least short term, but it’s more than reached the limits of its effectiveness. It benefits only the banks (hmmm, don’t suppose that would influence the Fed), and will probably leave us with a big mess to be hoovered up when it comes time to tighten.
An overvalued dollar has been a problem at least since the Asian Crisis. Will the powers-that-be finally do something about it, or are Turbo Timmy and his boss still afraid of stating the obvious fact that China is a currency manipulator (not the only one, but certainly the worst offender).
Also, if modest inflation is desirable, or at least the lesser evil, under current circumstances, then lowering the dollar is a good way to induce it. It’s also a fairly controlled way to do it, and hence less scary than printing money until inflation finally takes off.
It should be obvious even to Bernanke that QE produces a vicious circle. What it now fuels is bank and hedge fund speculation, endless reaching for yield through derivative games, reckless emerging market lending, currency raids, more crushing debt for populations trapped in the vice of predatory plutocrats and kleptocrats, operated at the whim of foozling technocrats, academic scammers, boondoggling politicians. All this has been cycling through the world economy since WWII, although the first twenty odd years looked benign from an American perspective and the only problem we noticed was the military idiocy which climaxed in Vietnam.
Finance capitalism ‘works’ only so long as collateral values keep pace with lending. When they don’t the game can’t continue until the debt is liquidated.
If the FED were to buy private assets, then it risks being view as a private enterprise, an agent of crony capitalism. If it buys only Treasuries, it risks destroying the market for Treasuries; i.e. it might become the only buyer.
“They will therefore refrain from trying more politically difficult, but more promising course, namely, restructuring debts and using government spending to cushion the impact, with a keen focus on measures that will restore competitiveness and reduce our trade deficit.”
Exactly – debt forgiveness, reducing outsourcing, etc. are the least likely of outcomes. It liberates we indentured servants of America, and that’s not what our plutocrat masters want.
Question
In our system all money created is part of leverage and/or debt. Our political system is hopelessly deadlocked. The crony capitalism is having its arse kicked by a command economy.
Our real problem is lack of growth not debt and it has been our problem for a couple of decades as we’ve allowed this command economy and the oil exporters to buy us.
Why can’t the FED simply print money to do a couple of things:
1) Finance energy independence.
2) Finance infrastructure repair and replenishment
If balanced books are that important do it a 1/4%. If you can value toxic assets at 100% of listed value I don’t see where this is that far fetched.
Maybe the Fed can’t print money to rebuild infrastructure and achieve energy independence, but there’s this possibility which Felix Rohatyn has been pushing for years.
parheel,
yes, I think the fundamental problem is lack of growth and then the debt instrument becomes a parasite on the economy by asking more in payment than it is actually producing in growth.
QE for the goals you point out (energy and transport) are valuable goals, certainly better than kicking the hell out of some towel heads in some part of a desert on top of some oil for vaguely religious reasons.
I was thinking that most modern history has been a large keynesian experiment, with the printing of money done by banks and allocated to what the market thought was productive, namely housing. Here is a clear case where a lot of “stimulus” (i.e. QE-like money created by the banks) went to a non-productive asset like housing. How do we dare think that the markets can be wrong? aren’t they supposed to be the ultimate capital allocators? think again….
Yves,
Your last paragraph is the point of the current problem.
Any form of QE is a debasement of the currency when the problem is that there is a very large level of debt that cannot be serviced. The cure for unservicable debt is restructuring. Restructuring really means liquidation and in the case of a sovereign, repudiation.
The sooner that is recognized and the sooner we deal with it, the sooner we shall begin to have some resolution of the great balance sheet recession that never really did end in second quarter of 2009.
MikeNY says — That leaves one adult in the house: The Fed. Regardless of how they’ve f*&(*d things up historically, what are they to do now, just sit on their hands, wait for the political crisis, and for Congress to act?
——————————————-
The answer — Yes, they should sit on there hands and MAKE Congress act. There is nothing in the Constitution about the Fed. Let’s face it the Fed has screwed up everything it has done since at least 1987 and prior to that made significant errors during LBJ that caused inflation to start roaring ahead to the level that people thought the Weimar Republic was coming to a state near you.
This is the problem with the Fed, there is no control on it. The power of the Fed should be drastically reduced to the point that we never talk about it again.
It seems to me that the root of our economic problems are fairly basic: We need to go through a depression to cleanse us of our excessively profligate ways (e.g., our irrational belief in ever inflating asset prices, our blind reliance on virtually unlimited leverage, our denial that a state whose governance has been captured in the service of certain corporate citizens can simultaneously do right by what we used to call the working classes). Moreover, if you believe in any form of free market capitalism, you can’t deny the reality of the business cycle which, if allowed to operate properly, actually serves a self regulating function by periodically cleansing the excesses produced by the irrational exuberance typically associated with economic booms. Given that reality, I am all in favor of targeted stimulus spending to reduce the burden that a depression will impose on the most vulnerable among us (e.g., food stamps, extended unemployment relief, productive public sector investment in real and productive assets). This kind of stimulus has almost nothing to do with protecting the large banks and financial institutions from being held accountable for their tremendous errors in judgment and their morally reprehensible behavior in exploiting consumers and productive businesses. As a result, I am in favor of letting market processes expose and freely value the bad assets that were wrought during the last decade of greed and corruption so that they can fall to whatever depth they should sink. At the moment trillions of those assets and their true values lie shrouded in mystery on the Fed’s secretive balance sheet and through the rest of the financial system where the suspension of mark-to-market accounting has helped to create a thoroughly misleading sense of financial solvency.
The Fed needs to recognize (a) that our past profligacy assures us that we are going to confront a long term depression whether we like it or not, (b) that some version of the truth will ultimately win out (exposing the lies and deceptions that are currently keeping the economy from completely collapsing) and (b) that the seeds for ultimate economic and social resurrection are most probably embedded in the process of living through that depression and rediscovering the social and economic values that we aggressively discarded over the past three decades in the run up to this crisis. If Fed doesn’t recognize the inevitability and necessity of a depression– and my guess is that they won’t– we are going to keep kicking the can down the road with tricks like bogus accounting and temporary stimuli. This delaying tactic is not without its targeted beneficiaries since– the longer the Fed can forestall the day of reckoning– the more those most responsible for bringing this collapse upon us will be able to detach themselves from any accountability for their crimes. But so also the smaller the chances that our nation will ever again be able to regain anything like the economic and political greatness we have, for so many years, taken too much for granted.
Ok,
So money is created by the banking system, through the money multiplier or more modern approaches like MMT (where debt is created first and reserves set later). So the money that we spent didn’t exist in the first place. It was created by the banking system. Then it does not result in productive assets. The banks get the goods.
So a bank had nothing, creates money and gets the goods in the end. China holds paper it recycles with us. But who is being conned here? Yes, you consumed beyond your means, but what moral value is there in imposing a depression now? for accounting purposes? but the asset side of accounting was based on the creation of debt in the first place. none of that money was real to begin with. Accounting is a false god from the 19th century, but the only one the markets have imho…
I agree with you that much of what we think of as money is produced through the banking system (“checkbook money” as distinguished from “central bank money”). I actually don’t agree with you about monetary reserves having any material effect upon the creation of “checkbook money” by the banks but I’ll simply refer you to the argument that I tend to accept rather than make the case here myself:
http://pragcap.com/your-textbooks-lied-to-you-the-money-multiplier-is-a-myth
You are right to say that banks have tremendous power. I would argue way too much power. Indeed, I find it more than a little frightening that folks worry as much as they do about the Fed creating “central bank money” when I think of the trillions of bad “checkbook money” that were unleashed into the system over the past decade and longer (and which are now, being unleashed once again thanks to Bernanke’s Greenspan II zero interest rate policy). I certainly believe in using the power of the Fed to provide targeted relief to people in need. But I believe this should be focused. This doesn’t mean bailing out banks that have made bad gambles or sustaining individual homeowners who happen to have become convinced that real estate should produce a guaranteed return of ten percent per year. (A rational single payer health scheme, on the other hand, would probably make a lot of sense as a means of mitigating the consequences of a sustained depression.)
My first response is that we need to face an honest accounting of all those worthless assets that are currently being propped up by a secretive Fed and the mandate of false accounting from a politically co-opted Congress. If we did this, we would start to confront the true extent of the fraud and the identity of the perpetrators. Recognizing the extent of these losses would, I believe, trigger a depression but it would also provide the firestorm necessary to finally reign in the extraordinary unchecked dangers that are once again spreading through various speculative financial transactions, including in particular the quadrillion dollar derivatives market and the the increasingly explicit TBTF backstop which is assumed as given in the post September 2008 world, at least as defined by current Fed and Treasury policy.
Second, I don’t buy the argument that money equals debt and therefore debt doesn’t matter. I believe that one of the false premises of this argument is that all debt (and the assets they finance) are equal. This is simply not true and an efficient capitalist market must have the ability to distinguish among different grades of investment using efficient and transparent market pricing mechanisms. If the market doesn’t do this, particularly given the mechanics of generating “checkbook money”, I believe the system is likely to self destruct when a super-abundance of bad assets (which in effect means bad money) reaches some unacceptably high level. And until it does self-destruct, allowing the creation of more and more “bad money” through a politically protected banking system will have the effect of continuing to siphon wealth from productive assets to speculative investments. (Remember that increasing the level of money doesn’t immediately translate into increasing the level of wealth unless that money is deployed in a productive fashion.) So even if the balance sheet balances, there is a massive wealth transfer going on that generally favors speculators over long term investors and undermines the non-banking portion of the economy and the faith of the citizenry in both their government and the economy.
Third, the financial system ultimately runs on trust. Much of the advances in financial technology in the last 30 years have been predicated on ways to arbitrage that trust for a quick financial profit. This, in turn, has led to a steady and continue erosion of public trust in our government and in our banking system. Allowing (what I believe constitutes) a multi-trillion dollar criminal counterfeiting by the banking class to continue unchecked is unlikely to go unnoticed forever. I’m not a gold bug but I am deeply sensitive to the limitations of fiat currency. If our financial system depends upon bogus accounting and central bank secrecy for its very survival– as I believe it does today– I think it will not be long before the wizard’s curtain is pulled back and the implicit Ponzi scheme is revealed for what it is. I wonder if the banking classes don’t realize this is happening and if they are doing everything they can to gather in as much as possible for themselves before that curtain is finally pulled back.
Fourth, the expectations that prevail in today’s market for real wealth and prosperity are, by and large, palpably overstated. They are based upon an asset bubble that has been expanding, by and large, over 30 or more years. If you know a way to lower those unrealistic expectations without a depression, please share it. My ideas aren’t set in stone. But we are, unfortunately, still a long way from a reality where people realize, to take just one example, that real estate is not a guaranteed cash machine (at least in a free market economy with a Congress that isn’t cravenly beholden to Realtors™). Case Shiller’s housing data demonstrably support the argument that residential real estate is, in general, still way over priced. My guess is the data will be even worse for CRE by 2014 when a lot of the intermediate debt that’s maturing will have faced the need to be rolled over. If you believe that people who bought a house are entitled to a 10% return per annum because government exists to insure that people earn the returns they think they deserve, I just plain disagree with you. Moreover, I think the consequences of that kind of policy action will ultimately lead to a fully Sovietized economy and (surprise) permanent economic stagnation.
One final point: I actually think that the US dollar will probably start to lose its status as the world’s reserve currency pretty soon (probably to be replaced by an SDR type arrangement; it’s way too early for China to fill the void). This move is likely to be accelerated by the continuing unwillingness of our central bank and our elected representatives to face the consequences of the run-amuck speculation that Wall Street has been promoting. In turn, I believe a move away from the dollar as the world’s primary reserve currency will lead to a gradual unwind of Triffin’s paradox (which has not only provided backdoor funding for our perpetual trade deficits and the associated fiscal deficits, but has also effectively masked the consequences of the growth of the dollar’s monetary basis as a large portion of those increases have been absorbed by the expanded reserves required by an expanding global economy). The result of this unwind will, over time, probably be a repatriation of increasing amounts of depreciated dollars in search of real assets. The good news is that when this happens, we will get a boost to asset prices and exports should pick up. But we will, on average feel poorer, since many of the dollars coming home will be converted into real assets that will no longer belong to us as a nation. So the dollars will be here, but the wealth, at least in part, will be lost forever.
Do not conflate markets with morality; the two are not and SHOULD not be the same. Markets must be functional, and because they are voluntary this requires agreement. Morality is rarely functional or voluntary, and you are unlikely to find a source of greater disagreement between any two people.
The point of liquidation – I’m beginning to love this word, now that Krugman hates it – is not to punish. Good and bad are economic terms only to the extent that they refer to the successfulness of business ventures. A failing enterprise is a cancerous element… it consumes resources while offering no social benefit (as measured by society through the markets). A speculative boom may reward businesses and actions that satisfy no want (or whose value is overstated, or not yet established), merely because investors have a chance to make money.
This is why liquidation in the ensuing bust becomes necessary. The speculative industries are not suffering from accounting imbalances or a fall in “aggregate demand”, but from lack of a raison d’etre. They are, outside of the peculiar logic of the boom, entirely frivolous. In this context, even good ideas and paradigm shifts become wasteful. Despite the value it gave us the dot com bubble also spawned an entire class of startups that had no product… they simply (and literally) capitalized upon the general mania.
Keynesian notions of the aggregate become laughable at smaller scale, and one begins to realize how wrongheaded it is to talk of demand as some disembodied force, with no relation to actual products and desires — and the ability, or inability, of an economy to provide and satisfy them.
Parsing the remains of the boom and deciding what is valuable and what should be gotten rid of is not the role of the government, because we do not yet know. Price discovery is the CRUCIAL factor in establish this, and there is no theory – and certainly no morality – that can substitute, if the goal is an economy that serves the people and not some golden idol. Preventing the free movement of prices and attempting to revive the excesses of the boom, as we are doing, is precisely the wrong course of action. In doing so, we compel people to invest in ideas and industries that we KNOW are bankrupt.
Stimulus merely substitutes one “bad” investment for another, and is impossible to provide in any meaningful amount without distorting the very prices that we are looking to for information. Same with quantitative easing. What the adherents of MMT do not (or refuse) to understand, is that the economy will respond and adapt to inflation and/or federal projects. You cannot interfere with the markets without also changing them, and alienating them from the purpose for which they were established: satisfying the needs and wants of the INDIVIDUAL. The legacy of centralized economies is, ultimately, a profundity of money and nothing to spend it on.
Diogenes — I generally agree with your comments, I just scanned them. We can not fix structural problems with monetary policy. Monetary policy is a form of make believe, but it only works when people do not know what is going on. Once people know what is going on they adjust accordingly. Also, monetary policy has a limited manner in distributing it effects and accordingly unexpected and undesired effects happen.
excellent.
A better alternative to the burn-and-purge Austrian approach would be to have a debt jubilee. The banks engaged in systematic fraud that gave rise to systemic risk, all to pocket short term gains (see Pro Publica link below). The idea that the victims of the banks’ fraud should have to pay back their debt AND suffer through a withering depression so that the banks can be made whole is ludicrous, but that is what the Austrian approach seeks.
http://www.propublica.org/article/banks-self-dealing-super-charged-financial-crisis
Baloney. Debtors that can pay should be obliged to honor the contract they signed, and creditors who cannot collect should be obliged to go bankrupt. The necessary losses should be (and would be, had we not intervened) divided amongst those on both ends of the poor decisions. You are right in saying that austerity is not fair, and this is why it should not be imposed through law or treaty.
Morally what you say is convincing. I’m not overly concerned though about the “laws of the market” as those laws are not natural laws, but simply what we choose to make them. The problem is that sometimes the cure, however morally desirable, is worse than the disease, even for those who had no hand in causing the catastrophe.
After the Civil War we had a general amnesty for those who had engaged in treason. It wasn’t morally right, but it was practical. If for the sake of the greater good we can forgive those who committed treason, debt forgiveness should be easy.
If steps are not taken to reduce hours of work, the “Keensian” collapse looms — Minsky’s model is all about hours of work and the conversion of industrial capital into financial capital to support consumption of a global glut of goods.
Let me offer a MMT view.
The modern monetary theory way to interpret the yields is to say that QE lowers yields and therefore, private investors will chase yield higher the food chain and therefore depress yields. This is a straightforward interpretation of QE and the current bond bubble. (btw, i think krugman is wrong in saying the markets are setting this, the central banks are).
At the same, you can argue that when a economy is growing by 0% anything that demands a fixed yield is a robbery. There should only be equity in a sense. So in the secondary market we are witnessing a collapse of yield, IN ACCORDANCE with a collapse of value of the investment. One could argue that this is essentially a fair recognition.
So I am caught in a dog-tail wagging problem. The pushing on a string theory only goes so far. As a private investor I would love if I could demand 15% yield on my money, but I just can’t. It so happens that the price of money reflects the current growth prospects and I think that is fair, even though it is against my own interest. Just for the sake of it, imagine the reverse case, where growth opportunities are slim and the price of money is superior to potential returns. That situation clearly is non-sensical.
I am repeating myself but QE as an application of modern MMT just tries to contribute a inflationary and stabilization dynamic against a globally deflationary backdrop. If you look at http://www.thedelphicfuture.org/2009/11/exponential-monetary-growth-permitted.html I have generalized the keen-andressen math to include equity and look at contraction. Bottom line: when debt spikes beyond return then you witness a exponential contraction in the money supply. This is the stuff depression are made of and the FED are right to inject money in circulation. To me that is bottom line and a justification of QE in and on itself.
QE 1.0 was trying to avoid the Fisher capsizing moment, where markets tank so much that deleveraging is a run-away dynamic of asset depreciation and ratio increase. At least deleveraging has happened (so far) without fisher capsizing THANKS TO QE 1.0. Chalk one up to Bernanke and the crew. It annoys to no end the criticism these guys get under fire. What a whiny bunch.
At a time when markets for CDO evaporated the FED stepped in to provide liquidity. The dynamics of money are such that a monetary contraction will lead to a solvency problem by mark to market. I do not think we should aggravate a solvency issue with a liquidity one. This would be repeating the mistakes of the great depression and the fisher collapse.
Finally, I struggle with the proponents of immediate pain and depression. So let me get this straight. There has been a generalized experiment in keynesian econ in the US where stimulus first went to military under reagan and housing under bush/clinton. A generation that had houses has partied and consumed like no other and now, those that didn’t have houses need to go through a depression to cleanse the sins of that generation? I cringe…. it is hard.
You’re dead right to cringe. But, as John F. Kennedy once famously said, “Life is unfair.”
I cannot escape the lessons that my parents’ generation (born early 1920’s, grew up in the ’30s) learned from their experiences during the Great Depression and how those lessons determined the economic decisions they made for their entire lives as adults. Moreover, I had the unique fortune of having my family ripped apart by the recession of the mid-1970’s. While I paid a heavy personal price, I also learned my own invaluable lessons which have driven most of the economic choices I have made over the subsequent 35 years of my life, choices which, I might add, have been very different from those made by the vast majority of my colleagues whose lives had, in the most cases, never been touched by any form of financial hardship.
A responsible government should, in managing a depression, choose to allocate a greater portion of the requisite suffering to those most capable and those most deserving of bearing it. I have no problem with a little economic justice, but tell me whom you would trust to dispense it? Surely not Ben Bernanke…
Oh great, so I should shoulder it all by myself, thanks.
Yeah, this topic is highly personal and emotional. To me the point sticks: banks create money, people spend it on stupid stuff, accounting view is shot… does that justify a depression? I am with krugman on this one. I view the gods of accounting with great suspicion. Between the fact the assets side of banks balance sheets were conjured out of thin air and that FAS157 is full of holes, I wonder why you are so keen on imposing pain on others.
The banks should *not* have been rescued, however, the equitable solution to this crisis was at odds with the fact that, because of central banking and the unbacked nature of our currency, we could not let them fail without a much greater reckoning.
Socialism and free markets do not mix well. The only solution is to choose one, or to accept inequity as the price we pay for our unwillingness to take principled action.
As for suffering, there is never any “fair” option. Either you suffer, or your children suffer. The choice was no different for previous generations. The world will never be perfect; but suffering is the price you must pay if you want hope.
“The banks should *not* have been rescued”
Heartily agreed.
“however, the equitable solution to this crisis was at odds with the fact that, because of central banking and the unbacked nature of our currency, we could not let them fail without a much greater reckoning.”
Sweden in the early 90’s had a central bank and an “unbacked” currency, yet they dealt with it equitably.
“Socialism and free markets do not mix well.”
At least if that socialism is for banks.
“As for suffering, there is never any ‘fair’ option.”
No option is completely fair, but some are less fair than others.
Scott Sumner has been a forceful advocate of looser money for some time. Here is his latest salvo, which I find quite persuasive: http://www.themoneyillusion.com/?p=6624
“But cheap money (except for scamsters) is not going to make a businessman wake up and say, “Gee, my borrowing rate has fallen 2% in the last six months. I really should go out an open an new store.” He’ll do that ONLY if money being 2% higher was a binding constraint. The prospects for his business are always a first order consideration, the cost of money second order.”
———
The same could be said for any interest rate at any point in time. Why would business ever expand because of lower interest rates since prospects for his business are always a first order consideration?
It seems a tall order of faith to say that there are almost no businesses with potential projects which have a projected positive return but not a return high enough to overcome the cost of funding.
During ‘brisker’ spending times the hurdle will be higher and cutting rates from 7% to 5% will launch any projects in the 5%-7% range that previously did not clear the hurdle….it is no different right now. There are more projects right now which have no possible positive return, but there are also many that have a low positive return.
The position that this dynamic somehow disappears when spending slows makes no sense. There are just as many expansion projects out there waiting in the wings as there ever have been….they are all just sitting at a lower rate of return. You can help boost spending to jump this rate of return or you can further lower rates to get under the lower rate. Be nice if we were doing both, but the Fed should not shut down just because Congress has decided to pack it in for the year.
When the original commenter said the prospects for business are a first-order consideration, he meant sales projections.
Recession means lower sales projections. So does economic uncertainty. And as yields plunge, they may imply lower nominal revenue growth, negating any borrowing rate advantage.
Hurdle rates for capital projects are often well above the prevailing interest rate. In a healthy economy, one would expect to have a palette of projects with double-digit ROIs. Whereas in a dismal economy, capital projects are postponed, and survival is the sole issue. In this situation, rate cuts are irrelevant.
Does anyone have a link to the video of Bernanke speech?
Whether or not there is QE, it does not address the fact that there is no organic driver of economic growth in the US right now and none coming for the foreseeable future.
“it does not address the fact that there is no organic driver …”
Details. Loose money can cure everything that ails (the banks).
Whatever the Fed does, its obligations are to the banks, not the pubic. So far the banks are not lending to the public sector for a variety of reasons and giving them more money will have little effect.
As for a depression, we really are in one now, and the government has shown less compassion for the poor, elderly, and disabled. They extended unemployment but cut food stamps. And their deficit commission is stuffed with rich, nasty fuckers like Alan Simpson who will try yet another grab at privatizing Social Security.
At this point I am torn between hunkering down and stocking up–or shooting a few bank CEOs and corporate-shill politicians. I bet most Americans feel as I do.
What will continued QE ultimately do to asset prices, currency stability, and protecting one’s cache of barterable and fungible commodities?
This is all you really need to know. Mr. Market knows. Mr. Market understands that dilution leads to pollution. We are now so polluted that only a massive flushing will heal the body. Ultimately the Fed has proven to be a lousy doctor and should’ve been indicted and stripped of its license for malpractice a long time ago.
http://www.apmex.com/
QE:
Yves, I’m having a problem understanding QE… would I be correct that having the FED by up debt so that banks will lend is similar to the way Fannie/Freddie work with mortgages? Like, is Bernake turning the Fed into a big Fannie Mae and Freddie Mac?
My rusty college Econ 101 recollection
of this…
QE simply put: the Fed creates new dollars out
of thin air — and they go out and buy stuff.
yeah, the FED has been doing that since March 09, I covered the initial step here
http://www.thedelphicfuture.org/2009/03/bernanke-is-dr-strangelove.html
I hope you like the bernanke picture I spent some time photoshopping it :)
QE is double speak for printing money or monetizing the debt. What it really amounts to is this: Debt = money, increasing debt = increasing money. Since all debt requires an interest payment in the next period even more debt has to be issued to create the money to pay the interest. Wash, rinse, repeat and you can see that this requires an exponential growth in debt. (A lower interest rate slows this growth rate down but unless it is zero it still grows.) Default on debt = less debt = less money supply. Oh no! How are we going to service the debt and pay for everything else if there is less money? Welcome to deflation.
So we have a large part of the debt market unable to pay the debts it has foolishly taken on and so the total debt is shrinking. In steps daddy government and says, if you won’t borrow I will, because we want to push this exponential equation to the point where we are required to add trillions of dollars to the money supply every month. (Yeah we know it will collapse eventually but we want to keep up the ponzi scheme as long as possible.) QE just creates more debt, i.e., more money supply to keep up appearances. No real wealth is created, that is, there is no added value in the creation of this debt so all that new money is chasing the same basket of goods, thus the inflation fear that goes with QE. If you debauch the currency via QE the though is that you can pay off that excessive debt load with cheaper dollars. Think about that for a minute. What it really means is that you can screw over anyone and everyone who is holding your currency, every citizen, every nation, everyone!
This is why QE is such a great plan. They all get screwed but don’t think they have been because they are holding more dollars in their hands at the end of the day.
QE flies in the face of the notion that money should be a store of wealth. A little 2% inflation rate over a 70 year lifetime means that if you could purchase a nice Mercedes 300 with your money at day one, that same money would buy you a Nissan Versa at the end. If you left your new Mercedes in the garage one night and the next morning you found a nice new Versa in its place would you say you had been robbed or would you be happy that you still had a car?
I am sort of reminded that QE is just another medicine (or drug? or even poison?) and cannot be prescribed without a consideration of the patient’s specific conditions and even the other medications that he is already taking.
The way I see it, we do not dare cure the economy so we opt for palliatives.
Yeah, I don’t think any of this matters. The
essence of the problem is that the middle-
class is dead and dying — crushed by
health care costs, and unemployment and,
blah, blah blah. Without the
middle-class, there’s no consumption and
there’s no recovery.
Helicopter Ben can debate all day how much
cash they should drop in on the banks or
other members of the politically
connected hyper-rich class, but what’s it
matter, if it doesn’t actually get to
a consumer somewhere?
All the QE will just end up to gambled on
a new bubble, or maybe they’ll build another
factor in China. I don’t see how any of this
helps normal people?
the answer is currency devaluation, but it is not possible.
QE2, in the forms consdiered (the outright rejection of higher inflaton expectations not being one of them) will do little – classic pushing on a string.
True dollar devaluation will do something, but it is not possible because
1.) China won’t allow it – they can beggar thy neighbor us to death (they can buy dollars hand over fist to keep their currency strong if needed – they have the surplus to do it safely).
2.) If it succeeds, the general price level will rise dramatically (solving many of our problems, including overuse and ignorance of the externalities of carbon based fuels – but I digress), and this would backfire severely putting the Fed under political pressure and likely ending their so called politcal independence permanently.
So instead we will get some half baked Qe2 which does little, if anything, except put money in the hands of those who need it the least. Wonderful.
‘China won’t allow it’ — everything is negotiable. China has 20 times the international reserves that the US has.
If China won’t yield, an interim approach would be to buy the ‘little dragon’ currencies of Hong Kong, Singapore, South Korea and Taiwan, to indirectly pressure China.
The US hasn’t intervened in forex since it bought euros at 85 cents in Sep. 2000. Nothing ventured, nothing gained. We’re not even trying.
Dollar devaluation is the same as inflation is the same as QE.
It doesn’t really matter how you do it, it’s still a means for stealing wealth from those who hold dollars hoping that said dollars are a store of wealth. The smart or lucky people will have converted their cash into a wide variety hard assets which will generally rise in dollar terms but stay constant in real value terms. (Has anyone noticed China’s hording of such hard assets? They aren’t stupid.)
While I generally agree with your thought in #2, a sudden rise in energy costs will cause a lot of human suffering and it will be most acutely felt by those who are on the lower side of the wealth scale. I would take a different approach to solving that problem, one that would be kinder to those who are on the edge.
“Dollar devaluation is the same as inflation is the same as QE.”
Not for Americans. Inflation in imported goods is better than inflation in everything.
“a sudden rise in energy costs will cause a lot of human suffering and it will be most acutely felt by those who are on the lower side of the wealth scale. I would take a different approach to solving that problem, one that would be kinder to those who are on the edge.”
Better to have a job and pay $5/gal for gasoline than to be unemployed and pay $2.50.
“China won’t allow it”
A good tariff threat should make them see reason. Without the US market their economy is toast, and they know it.
“If it succeeds, the general price level will rise dramatically”
It didn’t rise dramatically after the Plaza Accord. And to the extent we have inflation, it will be offset by increased investment and employment in manufacturing. Better to have a job in an inflationary period than to be unemployed in a non-inflationary one.
QE 1.0 in 08/09 was a RESOUNDING SUCCESS!
it averted fisher capsizing as the minsky bubble burst. What that means is that deleveraging happened without the debt/asset ratio spiking (fisher). CREDIT WHERE CREDIT IS DUE.
In other words we avoided negative spirals in asset prices (sell to reduce leverage, tank markets, tanks asset prices, increase leverage ratio needing further deleveraging). The outcome of the spiral is the dreaded fisher capsizing where deleveraging perversely leads to more leverage (in ratio). SO FAR we are deleveraging with some order. I like order.
QEII is the Fed thrashing about because the political system is broken.
Bernanke’s speech — SAME OLD, SAME OLD.
He keeps mashing the disconnected red button labeled ‘Excess Reserves Lending Channel,’ expecting a different result the next time, or the time after.
Pushing long rates down is counterproductive, as it reinforces expectations of deflationary recession.
The Fed should accumulate international reserves, and knock off the autofellatio act with Treasuries — it’s disgusting.
Jackrabbit — ITA.