Real News Network released a two-part interview with Michael Hudson on quantitative easing. While the picture is broad-brush, as TV necessitates, the talks provide a good recap of theory, or perhaps more accurately, political justifications for quantitative easing, as opposed to how it works in practice. The second part of the interview focuses on the use and abuse of quantitive easing in the Eurozone crisis. As Hudson emphasizes, QE is designed to keep banks afloat, and any help to the economy at large is incidental.
Below is Part I:
SHARMINI PERIES, EXEC. PRODUCER, TRNN: Welcome to The Real News Network. I’m Sharmini Peries, coming to you from Baltimore.
In an effort to relieve some pressure on the struggling European economies, Mario Draghi, president of the European Central Bank, announced a 1 trillion euro quantitative easing package on Monday. Quantitative easing is an unconventional form of monetary policy where a central bank creates new money electronically to buy financial assets like government bonds. And this process aims to directly increase private-sector spending in the economy and return inflation to target.
Well, what does that mean and what might be wrong with it is our next topic with Michael Hudson. Michael Hudson is a distinguished research professor of economics at the University of Missouri-Kansas City. His two newest books are The Bubble and Beyond and Finance Capitalism and Its Discontents. His upcoming book is titled Killing the Host: How Financial Parasites and Debt Bondage Destroy the Global Economy.
Michael, thank you for joining us, as always.
MICHAEL HUDSON, PROF. ECONOMICS, UMKC: It’s good to be here.
PERIES: Michael, the Fed and some economists will argue that this is what got the U.S. out of its 2008 financial crisis. In fact, they put several QE measures into place. So what’s wrong with quantitative easing?
HUDSON: Well, its cover story is it’s supposed to help employment. And the pretense is an old model that used to be taught in textbooks 100 years ago. The pretense is that banks lend money to companies to invest and build equipment and hire people. But that’s not what banks do. Banks lend money to real estate. They lend money to corporate raiders. They lend money to buy assets. They don’t lend money for companies to invest in equipment and hire. Just the opposite. They do lend money to corporate raiders, and when they take over companies, they outsource labor, they downsize labor, and they try to squeeze out more from the labor force, and they try to grab the pensions.
So the Fed was pretty open in what quantitative easing is supposed to do since 2008. It’s supposed to lower the interest rates, which raises bond prices, and it inflates the stock market. And since 2008, they’ve had the largest monetary inflation history–$4 trillion of quantitative easing by the Fed. But it’s all gone into the stock market and the bond market.
So what has this done? Well, it’s helped stock and bond holders get richer. And who are the stock and bond holders? They’re the 1 percent and they’re the 10 percent. And people are wringing their hands and saying, why isn’t the economy getting richer? Why is it since 2008 economic inequality and the distribution of wealth have worsened instead of gotten closer together? Well, it’s because of quantitative easing. It’s because quantitative easing has increased the value of the stocks and the bonds that the 1 percent or the 10 percent hold, and it hasn’t helped the economy at all, because the Fed is really concerned with its constituency, which are the banks.
One of the problems is that quantitative easing hasn’t even helped one class of investors in particular, pension funds. And it’s done just the opposite. Pension funds have made the assumption a few years ago that in order to break even with the rate of contributions that corporations in states and municipalities are paying, they have to make eight and a half percent, eight percent a year rate of return. But quantitative easing lowers the interest rate.
Now, lowering the interest rate has made these pension funds pretty desperate. The risk-free rate of return is less than 1 percent on government short-term Treasury bills. If you buy longer-term treasuries, you can make 2 percent, but then if the interest rates ever go up, you’re going to take a loss on investments. So pension funds have said, we’re desperate; what are we going to do? They’ve turned their money over to Wall Street money managers and to hedge funds. The hedge funds take a huge rake off of fees to begin with. But even worse, the hedge funds and the big banks–Goldman Sachs, Citibanks–when they see a pension fund manager coming through the door, they think, how can I take what’s in his pocket and put it in my pocket? So they ripped them off. And this is why there are so many big lawsuits against Wall Street for mismanaging pension fund money.
So the effect of the quantitative easing has been to make pension funds desperate, and it’s been to support real estate prices on the idea that somehow this is helping the high costs of housing help recovery. Well, they don’t help recovery, because to the extent that there’s been quantitative easing, they mean that new homeowners have to pay even more of their income to the banks as mortgage interest. And that means they have even less money to pay for goods and services, so the actual markets continue to shrink.
And what the quantitative easing has not been used for is really what was promised in 2008. Before President Obama won the election and took office, Congress said that the TARP bailout and the /tɛlf/ was supposed to go for debt reduction, that you didn’t create money, but it was to write down the mortgages, so that people could afford to stay in their home rather than the millions of phone numbers that have been foreclosed on and thrown out. But when Mr. Obama–even before Obama came into office, when the Democrats in Congress and the Republicans–Paulson, the secretary of the Treasury, said, yes, we’re willing to write down down debts. Obama said no, he’s not going to do that, and he ended up supporting the banks. So none of this money has been used for debt write-down. Well, exactly the same phenomenon is happening in Europe.
PERIES: So, Michael, this is exactly what the ECB is now proposing for Europe. So let’s take up the particularity of Europe in our next segment.
Thank you so much for joining us.
HUDSON: It’s really good to be here. Thank you so much, Sharmini.
PERIES: And thank you for joining us on The Real News Network.
And this is Part II:
SHARMINI PERIES, EXEC. PRODUCER, TRNN: Welcome to The Real News Network. I’m Sharmini Peries, coming to you from Baltimore.
I’m in conversation with Michael Hudson about quantitative easing. And if you watch the first segment, you’ll get a good grip on what it is and what’s wrong with that as far as the U.S. is concerned. And in this segment, we’re focusing on the ECB’s announcement on Monday about quantitative easing program for Europe.
And let me reintroduce Michael. Michael is the distinguished research professor of economics at the University of Missouri-Kansas City. His two newest books are The Bubble and Beyond and Finance Capitalism at Its Discontents. His upcoming book is titled Killing the Host: How Financial Parasites and Debt Bondage Destroyed the Global Economy.
Michael, thank you again for joining us.
MICHAEL HUDSON, PROF. ECONOMICS, UMKC: It’s good to be here.
PERIES: So, Michael, what’s wrong with with the ECB has announced in terms of a trillion euros worth of quantitative easing for Europe?
HUDSON: They head of the European Central Bank, Mario Draghi, has said that he’ll do whatever it takes to keep banks afloat. He doesn’t say whatever it takes to help economic recovery or to help labor more; it’s to help banks make more money because he used to be vice chairman of Goldman Sachs during 2002 to 2005. And his view is that of Wall Street and of the financial sector. It’s not a vantage point of helping labor or helping economies grow. So it’s not surprising that the trillion euros of new money that the Central Bank of Europe is creating hasn’t gone to help Greece, for instance, survive, hasn’t gone to help Greece, Spain, Italy, or Portugal get out of depression by fueling government spending. It’s been given away to the banks to buy bonds and stocks, including buying American stocks and bonds. It’s all the idea that if you can make the financial sector richer, if you can make the one percent and the 10 percent richer, it’s all going to trickle down. This is the view of Paul Krugman, it’s the view of the advisers that Obama has had. It’s trickle-down economics. And instead of trickling down, what it does is drive a wedge in the economy by increasing the value of stocks and bonds and real estate and wealth against labor. So it’s quantitative easing that is largely behind the fact that the distribution of wealth has become worse rather than better since 2008.
PERIES: Now, Michael, one of the things that has happened in Europe that you wrote to me actually in an email was the disappearing central banks’ role in stimulating economies. Why is this an issue?
HUDSON: Well, because central banks originally were designed to monetize government deficits. Government were supposed to spend money into the economy. And the idea of spending money into the economy is that that helps economies grow. Well, in Europe, the Lisbon agreements say governments can’t run more than a 3 percent of national income as a deficit. And the role of the central banks is not to give a penny to governments. They say that if you give a penny to government, you’ll have hyperinflation like you had in Weimar. So the central bank can only give money to banks to invest in stocks and bonds, but not any government spending at all. So the result of this policy of not funding government deficits is that the economy, to grow, has to be entirely dependent on commercial banks for credit.
Now, we had this situation in the United States in the last few years of the Clinton administration when the United States actually ran a budget surplus instead of a deficit. Now, how could the United States grow when there’s–running a budget surplus that’s sucking money out of the economy? The answer is the banks have to supply the money. But, again, the banks only supplied money in the form of junk mortgages, in the form of an economic bubble, in the form of takeover loans, in the form of a stock market bubble. And the interest of the banks is not in helping the economies grow; it’s in extracting interest from the economy. It’s using the wealth that people have to lobby for privatization and for selloffs that–essentially, when you privatize a public utility, you give away a monopoly and you deregulate the economy and you let the monopoly essentially set up tollbooths over the economy, whether it’s for toll roads or from communications or for whatever is being privatized as Greece is told to privatize. So you have quantitative easing is a policy going hand-in-hand with the insistence on privatization such as Greece has. So you’re having not only debt deflation as a result of depending more and more on the banks for the money to grow rather than on government spending into the economy. You’re having the governments not being able to spend on infrastructure, letting it fall apart, as is happening in bridges and tunnels in the United States. And then the government says, I’m sorry, the central bank doesn’t have enough money to help us build new infrastructure; we’ve got to sell it off to private investors who do have the money. Well, then you have the whole economy ending up looking like Chicago, which sold off its roads and its sidewalks and its parking meters to Goldman Sachs and to Wall Street, and all of a sudden the prices of parking, of driving, of living in Chicago went way, way up, and instead of lowering the costs as privatization promised, you have exactly the same phenomenon happening here that you had under Margaret Thatcher in London: the costs go way up. Transportation costs go way up. Road costs go up. Communications, internet costs, telephone costs, everything that is privatized goes way, way up. And the result is we’re turning into a rent-extractive, almost a neo-feudal economy.
So, in that sense quantitative easing and the refusal of central banks to fund governments, but only to fund commercial banks, is a new kind of class war. And it’s not the old kind of class war, which was simply between employers and their workforce over what wages will be. It’s by the financial sector trying to take over the economy, and especially to take over the public sector, to take over the public domain, to take over public utilities, to take over whatever assets a government has, and to force governments to–essentially, if governments cannot borrow from central banks, they have to begin selling off property.
PERIES: Michael, this is exactly what’s happening in Greece right now. The SYRIZA government is somewhat forced to continue privatization as a part of the agreement of the loans that they have been given by European banks. What could they do in this situation?
HUDSON: Well, this is really a scandal, because most privatizations are corrupt. In Greece, they’re almost as corrupt as they are the United States–well, nothing could be that corrupt. But the SYRIZA Party coming in said, wait a minute, the privatizations that have been done are by a governmental people to their own cronies at a giveaway price. How can we balance the budget if we’re giving away the public utilities instead of getting a fair price for them? The European Central Bank said, no, no, you have to give away privatization to cronies at pennies on the dollar just like Russia did under Yeltsin, just like the United States did with the railroad giveaways of the 19th century.
And remember, the American privatization [incompr.] cronies created essentially the ruling class of the 20th century. It created the stock market. Well, the same thing’s happening in Greece. It’s told, create a new oligarchy, endow a new kind of a feudal lord–although in the case of some monopoly lord, by giving them away, these privatization giveaways–and if you don’t do that, we’re going to bankrupt the banking system. Well, Varoufakis went back to the party congress in Parliament and said, will you approve this? Well, so far, the left wing in Greece has said, no, we won’t approve the giveaways. This is crazy. The pretense is that privatization is to make money. But the European central bank is really saying, no, no, you can’t make money; you have to give it away to your cronies, who are our cronies, and it’s all one happy financial family. This is escalating financial warfare.
And so I can assure you that neither Varoufakis nor SYRIZA has any interest at all in this kind of privatization giveaway. It’s trying to figure out some way of perhaps prosecuting the cronies for bribery, for internal connections, or figuring out some way of legally stopping the rotten policies that they’re told to follow by the European Central Bank, which, again, isn’t giving a single euro to Greece to help it get over the debt problem. The euros are only given to the financial sector to help declare war on the Greek government, the Spanish government, the Italian government. It’s really financial warfare trying to achieve the same thing that military warfare did in the past. It’s trying to grab the land, to grab control of the public infrastructure, to grab control of governments. And it’s doing it financially rather than militarily.
PERIES: Right. Michael, the SYRIZA Party last week did agree to the conditions of privatization, that they would not roll back on the existing agreements that had been made by previous government. They agreed to not roll back on ones that are underway, and that there actually not even averse to privatization as a statement by Yanis Varoufakis. What does all this mean for Greece?
HUDSON: The financial gun was put to their head, and if they wouldn’t have said that, there would have been a total breakdown, and the European Central Bank would have tried to bankrupt the Greek banks. So he didn’t have a choice. Everything that Varoufakis has written and all of everything that the political leader of SYRIZA has said has been exactly the opposite. So they had to give lip service to what they were told to do, and any agreement that’s made actually has to be ratified by Parliament. And so, what they’ve said is, okay, we’re going to play good cop, bad cop. We’ll be the good cops with you and we’ll let Parliament and our left wing be the bad cops and say, we’re not going to stand for this.
PERIES: As always, Michael, thank you so much for joining us. It’s always fun to have you on. And it’s so sad that issues we’re dealing with are so tragic for the people.
HUDSON: It’s really good to be here. Thank you so much, Sharmini.
PERIES: And thank you for joining us on The Real News Network.
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Thank you for this. As Dr. Hudson discussed, the situation in Greece and what has occurred in the U.S. in the aftermath of the financial crisis clearly illustrate why retention of monetary sovereignty and policy control over fiscal spending are so critical for governments.
‘Central banks originally were designed to monetize government deficits.’ — Michael Hudson
Yes. More specifically, they were designed to monetize the largest, most urgent government deficits, those required to finance wars.
The Federal Reserve is permanent war finance. And by no coincidence, the US is at permanent war, keeping local conflicts on the boil all over the planet.
Extirpating the cancer of the welfare-warfare state requires cutting off its financing. Recognizing that QE is counterfeiting — a destructive fraud upon the public — is the step needed to shut down the Fed’s depredations on behalf of banksters.
“Extirpating the cancer of the welfare-warfare state…”
A shopworn libertarian construct. As if one necessarily requires the other.
We are all, or soon will be, on welfare.
The cancer of the permanent warfare still needs to be extirpated.
The only concern we have should be how to get money to the People directly and immediately.
Welfare for warfare was a synthetic offer we couldn’t refuse. Because we didn’t want to starve to death. It still is. What we need to do is to screw warfare and create a sufficient safety net for all of America (and the world – tho’ most of them are way ahead of us uncreative warmongers). The banksters have given us the same ultimatum. And QE, as Varoufakis, Parteneau, and others have said, is debt ponzi at this point because everything the old system does is extractive. That pension funds are desperate to make their payments is a national disgrace. There are solutions to this crap.
QE is the brilliant plan that Central banks devised that allows them to print countless trillions without generating inflation. The just give all the money to the already wealthy 1% who do not circulate it and presto…no inflation.
“But when Mr. Obama–even before Obama came into office, when the Democrats in Congress and the Republicans–Paulson, the secretary of the Treasury, said, yes, we’re willing to write down down debts. Obama said no, he’s not going to do that, and he ended up supporting the banks.”
As I said before and the Obots refuse to believe, Obama alone wanted the bailouts with absolutely no strings attached and he got what he wanted. …
a definition of evil is the committing of ordinary bad acts on a scale that should be unimaginable.
Thank you for this analysis.
I’m particularly interested in this statement:
“And since 2008, they’ve had the largest monetary inflation history–$4 trillion of quantitative easing by the Fed. But it’s all gone into the stock market and the bond market.”
Some people such as Mosler suggest that QE doesn’t do anything as it just exchanges cash for bonds and the money is kept within the banking system in the form of excess reserves.
I can understand how buying MBS type securities helps fortify a failed asset. Some central banks have admitted to outright buying equities but I don’t think the Fed has admitted to this.
What is the mechanism you see that gets these funds into particularly the stock market?
> What is the mechanism you see that gets these funds into particularly the stock market?
I think the larger point is the Fed spent $4 trillion into existence on something with very unclear effects. When it could have just as easily funded $4 trillion of fiscal stimulus that actually would have made a material difference to improve the economy. The stock market boom/bubble is based around ZIRP — I don’t think most people here would say QE directly fed into it.
Investors can no longer get real returns from safe investments like high grade bonds. So QE, which suppresses interest rates, leads them to pile into stocks and riskier bonds and foreign investments. From Ed Harrison:
Look, quantitative easing is an asset swap. The Fed creates electronic credits and swaps them with existing financial assets. If the Fed is buying government paper, it is essentially trading one government liability for another, swapping a demand deposit electronic credit for a longer-dated government asset.
“From the government’s perspective, there is no functional difference between any of its obligations like bank notes, electronic credits, or treasury bills and bonds. As the Ten pound note says, “I promise to pay the bearer on demand the sum of [fill in the blank sum][fill in the blank fiat currency].”
So QE2 Is Equivalent to Issuing Treasury Bills. In actual fact, all QE2 does is drain the real economy of interest income by swapping an interest-bearing government liability for a non-interest bearing government liability. This decreases aggregate demand in the economy. So the real economy effects of QE are to slightly lower aggregate demand. This is offset by changing interest rate expectations, which alter private portfolio preferences, and lower risk premia, leading to credit growth, leverage and speculation, forces which should pump up the real economy. The Fed had intended to lower interest rates via the lowered risk premia. To date, the Fed has lowered risk premia. But this has also provided the tinder for speculation and leverage. Moreover, the Fed has also raised inflation expectations to boot, causing interest rates to rise and working at cross-purposes with the lowered risk premia. Thus, QE2 has only been successful insofar as it has increased business credit and raised asset prices. In my view, QE2 has been a bust as it adds volatility to the system and will have negative unintended consequences down the line.
https://www.creditwritedowns.com/2011/03/how-quantitative-easing-really-works.html
QE is a portfolio swap. Investors sell their bonds to the Fed and get cash. They then reinvest that cash into something else.
Thanks. It also seems that the Fed is buying more than Treasuries. From your second reference below:
“It might be asked: if banks cannot lend the excess reserves that the central bank provides, what is the point of the central bank supplying them? The answer to that question is simply that QE does serve to ease financial conditions. Technically, QE allows the central bank to change the composition of the aggregate portfolio held by the private sector; the central bank takes out of that portfolio the government debt and other securities it buys and replaces them with reserves and bank deposits (the latter when it buys assets directly from the public or its nonbank financial intermediaries)”
It would be interesting to know what the ‘other securities’ means.
As this is the way the Fed handled the last crisis:
http://neweconomicperspectives.org/2014/01/greatest-myth-propagated-fed-central-bank-independence-part-1.html
“The Fed handled most of the US policy response to the Great Recession (or, GFC). As we have documented, most of the rescue was behind closed doors and intended to remain secret. (See Felkerson 2012; and Wray 2012)[5] Much of it at least stretched the law and perhaps went beyond the now famous section 13(3) that had been invoked for “unusual and exigent” circumstances for the first time since the Great Depression”
How are they going to handle the next one?
It seems to me that low rates in particular and QE to second order is a drag on bank net interest income. I was under the impression that the financial sector wants to see ZIRP end and has been calling for higher rates. I think that on balance, the efforts by the central bank to lower rates is based on the belief that the market clearing interest rate is very low (and possibly negative). That makes perfect sense to me — we are not seeing an explosion of inflation as households rush out to spend their liquid assets even at zero rates. It may well be that rates should be substantially negative (a transfer from creditor to debtor) in order to restore growth.
Notwithstanding any criticisms of the governments supervisory rule, current interest rate policy is rooted squarely in an assessment of what market clearing rates happen to be. Pushing rates to a higher level not required to limit excessive consumption is a bit like advocating for above market-clearing prices for some special interest group, in this case bond holders.
increasing bank reserves enables banks to extend more credit at very low interest rates. The Fed’s QE has reduced the cost of c refit to banks to 0.1%. They can make a profit lending for corporate takeovers, and for margin credit.
As for “exchanging cash for bonds,” this bids up their price — lowering interest rates.
Thanks for the reply. I have to admit to still being confused on reserves. It seems that banks can create loans as they wish and then the necessary reserves follow.
I see their making loans for corporate takeovers and margin credit as something being backed by assets as you have talked about rather than lending for productive investment which would probably best be done by public banks or directly by the federal government such as with DARPMA or NIH.
Similar to making loans on homes using the properties as assets, I can see them getting burned on corporate bonds and equities. It would be interesting to know how many of these corporate bonds and equities the Fed already owns or how many they would plan to buy in the future if necessary to re-save the banking system.
No, banks are never reserve constrained. Banks are now sitting on tons of excess reserves anyhow, but if banks lend and they can’t find enough reserves from other banks to meet their reserve requirements, the central bank will create more. It has to do that to be able to maintain its rate targets.
Reserves have nothing to do with lending. We are not in a fractional reserve banking system. As Ed Harrison wrote in 2011:
Some people still believe in the money multiplier taught in old economic textbooks that fractional reserve banking has banks taking deposits, multiplying them as much as possible, subject to the reserve ratio, and making a much larger amount loans. That is not how it works. In practice, banks don’t wait for the reserves to be available to issue loans. They make loans first and then borrow the reserves in the interbank market. The loans come first, not the reserves.
Banks are never constrained by reserves or reserve ratios. Banks are capital constrained. In our fiat money system, the central bank uses reserves in the system to help the it hit a target interest rate. So, the central bank provides the system with enough reserves to meet any reserve ratio at its target rate. The reserves are about helping set interest rates, not about pyramiding money on a reserve base.
Understanding this should also help you understand why QE has been a boon for financial speculation but a bust in the real economy.
http://www.nakedcapitalism.com/2011/05/banks-are-not-reserve-constrained.html
See a longer form treatment here:
https://www.kreditopferhilfe.net/docs/S_and_P__Repeat_After_Me_8_14_13.pdf
Here’s a dated attempt at a video explanation (a Chinglish spoof). QE in 77 seconds.