Quantitative Easing

Quantitative Easing

November 30, 2008

 

There is a lot of talk that the Fed’s most recent $600B GSE + $200B consumer credit buyup plan constitutes “quantitative easing.” For me, it’s a little too early to say what’s going on here. Up until now, the Fed has been essentially recycling Treasury deposits at the Fed. The Treasury issues bonds and deposits the cash received at the Fed, just like you depositing a paycheck at your bank. The Fed then lends this out (or buys debt securities, same thing), just like your bank. So, no new money creation there. However, it appears that this new facility will be explicitly funded via the printing press.

If so, that would be a major milestone. Maybe the Point of No Return.

What the Fed buys with the cash is not actually all that important. Buying $600B of GSE debt might raise the price (lower the yield) of GSE debt a little. So what. Same for the consumer credit paper. You might argue that the combo is a little like “throwing money out of helicopters,” although that is not quite right. Consumers have to borrow the money. They still have to pay it back! So, maybe it would make a little more credit available to consumers than would otherwise be the case. Congresspeople have been giving the Fed/Treasury a hard time about that. In my opinion, there hasn’t really been a consumer credit crunch thus far. Credit for consumers is still too lax. When you have consumers crying to their Congresspeople about the burden of paying back consumer credit, rather than crying about access to credit, then you’ll know we’re getting somewhere. When consumer credit becomes a cashflow-negative proposition, then the whole thing goes kerflooey for the overindebted consumer, and consumers start treating credit like poison rather than begging for more of it. I figure this point will be reached by next June or so.

No, it’s not the buying, its the funding of the buying that’s the interesting part. Expanding the monetary base by $800 billion or so could have rather dramatic consequences.

I’ve said many times that the combination of interest-rate targets and floating currencies is a very chaotic situation. All kinds of funny things happen. When enough funny things happen, central banks start to adopt some sort of “quantitative” program. Volcker’s monetarist system of 1979-1982 was a sort of “quantitative tightening ” program, inherently confused as it was. The Asian governments used “quantitative tightening” techniques to get their currencies back on track in 1998. The outcomes in both situations were messy but effective. Note that the goal, in each case, was not to try to affect credit, but to support the value of the currency.

The problem in Japan in the 1990s was never credit, but the value of the yen, which had risen to deeply deflationary levels. This problem was not solved by the BOJ’s lower-interest-rates policy. Around 1998-1999, I was one of those economists who argued that the BoJ had to “print money” to reduce the value of the yen to a less deflationary level. The BoJ did this, and it worked, eventually. It could have been done much more effectively, and if paired with some real tax cuts the result would have been very powerful. In some ways, the BoJ’s actions were sort of like the flip side of Volcker’s actions in 1980. In those days, high interest rates didn’t really support the value of the currency (“funny things”), so they tried the quantitative approach. In Japan, low interest rates didn’t depress (“reflate”) the value of the currency, so, once again, a quantitative approach.

This is completely different than the present situation in the U.S. The dollar, despite a rather powerful rally over the past few months, has been on a consistent downtrend in value. In this case, “quantitative easing” is likely to accelerate this downtrend. This could turn out to be very, very bad.

January 27, 2008: Crisis Management

A dramatically lower dollar value, achieved through “quantitative easing” or what have you, can actually help resolve the credit problems. U.S. nominal GDP fell 42% in the 1929-1933 period. Economists like Ben Bernanke argue today that if the government had basically devalued the currency (they don’t understand that this is what they are arguing but that’s basically what it is), then nominal GDP might have been, say, up 20% instead, which would have made debt repayment much easier. The thing is, you would have to devalue by a huge degree. Britain, Germany, and Japan — and all of their associated empires, amounting to dozens of countries — devalued in 1931, by a relatively large amount, but that did not produce this kind of outcome. Prices don’t just zoom up over a couple weeks, not even in a place like Iceland after their huge currency decline. Imported food might be 5x more, but rents are still about the same (in krona), because people’s incomes are about the same, and there are long-term contracts. And, today, the previous credit underwriting was sooo bad, and excess of credit availability was so acute, that I think it would take very dramatic means indeed to try to solve this credit problem via the printing press. A better way to solve it, in my opinion, is to just make it disappear via the bankruptcy process.

April 13, 2008: This is So Not Like Japan

So, what am I trying to say?

1) The theory behind this “quantitative easing” approach is flawed. Such approaches have worked in the past as a means to correct the value of the currency, not to (lapsing into metaphor economics) “poof some air into a deflating economy”. When you get right down to it, after all the various academic justifications, isn’t policy really being driven by some silly metaphor such as that?

2) It isn’t Japan, and people who say that it is, like Ben Bernanke, don’t know what they’re talking about.

3) Printing money outright, when the currency has already been on a downward trend, has historically been the precursor to hyperinflation.

4) I doubt these guys know what they are doing. They are just throwing things to a wall to see what sticks. They’ve been throwing more and more things to the wall even before they have a chance to see if their previous things stuck. Things are out of control, and likely to get more out of control.

The real danger is if other people, especially foreigners, especially foreigners who own U.S. assets, begin to come to the same conclusion.

* * *

Get ready for The Ratchet: Do you wonder what happens after the big spending programs? The goverment spends a lot of money, let’s say 5% of GDP. This actually works — it causes economic activity — for as long as the money is flowing. The effects are tangible enough to get the big-spenders excited. See — it works! However, the overall effects are generally rather disappointing, because the various “multipliers” and so forth are mostly a fantasy. So, the overall economy is still in rather poor shape. This makes policymakers hesitant to turn off the tap, because they sense, correctly, that once the money stops flowing, the dancers return to their seats. The next year rolls around. According to the Keynesian arithmetic, if spending is cut, to 3% of GDP perhaps, which is still 3% more than it was at the beginning, that would cause a contraction of 2% of GDP! Can’t have that. And, if you want to maintain “stimulus,” you have to spend even more than the present 5%, which has already been shown to have somewhat disappointing effects, interpreted as “not enough” by those addicted to government spending. Last year’s “stimulus” is this year’s baseline. So, it being determined that “more stimulus” is needed, the excess spending goes from 5% of GDP to 7% of GDP.

Thus, the Ratchet. This causes monster deficits, which tends to cancel any attempts to cut taxes, and introduces, among the fiscally conservative who are appalled at the insane 7%-of-GDP spending on waste, an urge to raise taxes. Clearer heads may say “yes, we will raise taxes in the future, but not now.” The problem is, they said that a couple years ago. The future has arrived. It’s now time to pay for the past spending programs (or at least it will seem that way to them). Not to mention that the exploding government debt may introduce funding problems.

More reasons why I shy away from big spending programs. A little bit is OK. I think the New Deal-era deficits amounted to 3% of GDP or so. Considering the low debt/GDP ratio of those days, not the worst thing ever. The CCC, WPA, jobs for artists and journalists etc. type stuff helped keep a lot of people on their feet. That’s why I look at the whole process as more of a welfare policy than an economic policy.

* * *

Steve Forbes is a gold guy from way back. He made a pitch for a new world gold standard in his op-ed in Forbes.

http://www.forbes.com/business/forbes/2008/1208/019.html

Richard Duncan said “Bring Back the Link Between Gold and the Dollar” in the FT.

http://www.ft.com/cms/s/0/ba673d22-b977-11dd-99dc-0000779fd18c.html?nclick_check=1

I think the gold guys are getting beyond their “please don’t laugh at me” stage. It would help if more of them knew exactly how to accomplish this task, like readers of this site know.

* * *

We’ve had some full winter weather here, with lows around 13F and highs around 26F. It has been a decent trial run of my various heating tweaks.

1) The “kotatsu desk” is a huge success, but the office is still damn cold in the mornings when it is below 20F outside. I gave up and put on my down jacket — problem solved.

2) The kitchen/living area doesn’t quite make it with just the 800W electric heater, although this is enough in the middle of the day when the sun is shining. For the mornings and evenings, I added a 8000btu propane heater, which is mostly on the low 4000btu setting. At 4000btu, I figure a 20lb tank ($16) would last about 108 hours, or about a month @ 3 hours per day. So, we should be able to bring it in below two tanks for the month I’d guess.

3) The pipe heater tape has come on a few times, when it’s below 20F outside. It has used about 3kwh during the cold nights.

4) I haven’t added the thermal paint yet, and I left one large window uncovered for aesthetic reasons, that I was planning to fill in with the foam/foil board. So, we’re not quite at 100% yet.

5) The 42F “backup” heater came on once for about an hour. Except for that, we’ve had no heating during the nights, which has been fine. My speculation that it wouldn’t turn on until it was -13F outside was a fantasy. I would guess more like 12F outside is the turn-on point.

6) The extra heat generated by things like the kitchen stove or even extra people (guests) is really noticeable.

7) With all that in mind, the 500W generated by our computers when they are on would nicely heat a small office-sized space, if it was properly insulated.

This is about as much as you can do by retrofitting an existing structure. However, it does suggest that if you were to build a structure from scratch, with superinsulation in mind, it would indeed be possible to go a few steps beyond this to something that hardly needs to be heated at all.

My electric heating bill (heating only) for November was $39.45, assuming $0.15/kwh electricity, which is high.

* * *

Lyndon LaRouche: Bankruptcy now!

http://www.rense.com/general84/bak.htm

In this setting, Lyndon LaRouche said today: “Why don’t they try bankruptcy? We should put this out clearly: You damn fools; you should put this thing in bankruptcy! You don’t have enough money in the universe to pay this bill! So why don’t you admit it! We should say that; exactly that. We shouldn’t do any reporting of this stuff, because reporting it is being impotent in the face of it. Just say that there’s not enough money in the universe to pay this damn bill. They can’t do it; they should declare bankruptcy, and just cancel all these damn derivatives. We’ll protect the firms that are driven into bankruptcy, in bankruptcy reorganization. We have no other course except to put this thing into bankruptcy.

“We’re about to launch the greatest hyperinflationary burst in modern history,” he continued, “unless we stop this. We’re on the verge of a hyperinflationary explosion; they’ve been trying to conceal this hyperinflationary thing by various tricks so far. Now it can’t work any more! So they’ve got to put the thing into receivership! Put it into bankruptcy now! That should be your headline on everything. There is nothing to do with this thing except put it into bankruptcy. Paulson, stop being a Christian Scientist! Take your medication! Don’t be a Christian Scientist all your life; take your medicine!

I kinda like Lyndon LaRouche. He says what’s on his mind, and he’s not wishy washy about it. He sounds like he speaks from experience, rather than speaking from an opinion about something learned in skool, like most economists.

The policy must be to put Citibank and other banks under bankruptcy protection of their normal banking functions, which means freezing all claims based on the speculative investments called derivatives. No bailout for derivatives! Freeze them!

Put the whole thing into bankruptcy and supply the protection to the regular functions of the banks. Then you don’t have to pay out all that money, you damn fools! You don’t have to put a nickel more into bailouts! Just put the thing under bankruptcy protection as I’ve told you all along!

Are you starting to wonder why Helicopter and Hanky Panky are making such an obvious effort to avoid bankruptcy? I suspect it is because the present shareholders would get blown out. I’m not talking about some stupid index fund. There are certain entities who have been amassing controlling stakes in major banks for generations. They could lose that control, and with that, lose control of other things as well. For these kinds of control-freaks, that is an unimaginable outcome.

* * *

Paul Krugman had a decent blog entry on the Fed during the early 1930s.

http://krugman.blogs.nytimes.com/2008/11/28/was-the-great-depression-a-monetary-phenomenon/

90% of what is written about the Great Depression is not actually about the Great Depression. It’s just politics. For example, the idea that the Fed caused the Great Depression is really a variant of the Government Meddling Causes Problems theme, which is a favorite of conservative types everywhere. I, for one, think governments cause a lot more problems than they receive blame for. However, in this case, the Fed didn’t really do much of anything, except what it was supposed to do, which is to serve as a “lender of last resort” in the classical, Bagehot fashion. Paul “Conscience of a Liberal” Krugman is obviously a self-appointed hack for the other side of the aisle (he wouldn’t have a berth at the New York Times if he did not declare, loudly and repeatedly, that “I am a hack!”), so he makes the argument that there should have been more government intervention, which is really just a variant on the Big Government Will Save the Day theme — needless to say, a favorite of lefty types everywhere.

Here’s one of Krugman’s big government themes, from the same day:

http://krugman.blogs.nytimes.com/2008/11/28/too-much-of-a-good-thing/

Too much of a good thing … Is only prudent. As far as I know, nobody has written up the case for a fiscal expansion larger than our best estimate of what’s needed to close the looming output gap.

The Great Depression wasn’t caused by the Fed, and neither was it caused by a Shortage of Government. I’ve already mentioned Herbert “Conscience of a Conservative” Hoover’s choice to raise the top income tax rate from 26% to 63% in 1932. However, Roosevelt raised the top rate to 79% in 1936 and 81% in 1941, and it finally went to 91% in 1945. So, both leftys and rightys got into the game, and now, seventy years later neither side wants to point to that factor, do they? Cover Your Ass is politics 101.

* * *

Unfortunately, you can be a tall pointy hat-wearer whether you are a gold guy or a soft-currency guy. This week’s it’s-not-a-wizard’s-cap-duh! award goes to:

“Mechanically, reverting back to a global gold standard would be straightforward. First, an intrinsic
global value of gold would have to be defined in order to convert various paper currencies. If the
original Bretton Woods agreement were to be used as a model, we first divide the respective sizes of
each central bank balance sheet by its corresponding official gold holdings. For example;
• The Fed reports official US gold holdings to be roughly 8,100 tonnes, which equates to a US
dollar value (at $800/oz) of approximately $230 billion.
• The US Federal Reserve’s balance sheet liabilities (private banking system reserves) are
approximately $1.75 trillion.
• Therefore, the US dollar would have to be pegged to gold at somewhere around $6,100/ounce.”

http://www.ritholtz.com/blog/2008/11/a-not-so-modest-proposal/

Here’s how you’re supposed to do it:

November 23, 2008: Redeemability and Reserves

I’ve said that we won’t get a gold standard until the gold guys are able to present a coherent, working plan — like David Ricardo did in 1817. It doesn’t even have to be a perfect plan, as long as it is close enough that it could be tweaked into shape. Obviously, we are falling rather short of that mark.

* * *

Another piece in Pravda.ru.

Russia’s Currency Crisis

* * *

Japan: Failure to Identify the Problem. Richard Koo, a big name strategist at Nomura, in my opinion totally fails to Identify the Problem in regards to the situation in Japan.

http://www.csis.org/media/csis/events/081029_japan_koo.pdf

There is nary any mention at all of the various tax hikes, particularly the enormous tax hikes on property in which effective property taxes rose about 10x if not more, and no mention of Japan’s deflationary monetary conditions. About par, I figure.

* * *

It isn’t stealing if it’s over a billion: Enrico Orlandini sums up the Citi boondoggle:

What did happen though is that the rich get richer at your expense. By that I mean that the Saudi prince announced he was increasing his stake in Citibank when the share price hit $3.50 just several days before the bailout was announced. If you think he did that without talking first to Bush and then to Paulson, I have a bridge in Brooklyn I would like to sell you. He bought, the bailout was announced, the price goes to US $7.05 and the price makes a cool billion or two at your expense. Where is the SEC and charges of insider trading? Nowhere to be seen; or maybe following Martha Stewart around trying to see if she made another $30,000 in ill gotten gains! These types of dealings have been going on for so long now that they have become the rule rather than the exception. The Prince walks away with a quick billion and the American people are stuck with a bill for US $322 billion that Citibank will never be able to pay.

Was there any mention in the Mainstream Media that the U.S. taxpayer paid $25 billion for 7.8% of Citi when the whole company had a market cap of $20 billion? That’s equivalent to about $56 a share!

Fresh Prince: gets a phone call from Hanky Panky. “Buy Citi at $3.50. Trust me.”

U.S. taxpayer: Hanky Panky buys at $56.

* * *

Famine ahead? People watching the farm belt are getting real nervous. Global grain stocks are already at post-WWII lows on a per-capita basis.

http://www.dailykos.com/storyonly/2008/11/27/11143/168/114/667032

Also, even when there’s plenty of food, financial issues can lead to starvation. An estimated 7 million Americans died of starvation during the Great Depression.

http://sharonastyk.com/2008/05/25/fascinating-read/

This was even while the U.S. government was buying farm products and dumping them in the ocean. The population of the U.S. was 123m in 1930, so that would work out to 17m deaths from starvation for today’s population of about 300m. Of course, many people do not actually die of starvation directly. Often, they are so weakened by malnutrition that they succumb to disease, hypothermia, etc.

As Monetary Authorities, we have been humbled and have taken heart in the realization that some leading Central Banks, including those in the USA and the UK, are now not just talking of, but also actually implementing flexible and pragmatic central bank support programmes where these are deemed necessary in their National interests.

That is precisely the path that we began over 4 years ago in pursuit of our own national interest and we have not wavered on that critical path despite the untold misunderstanding, vilification and demonization we have endured from across the political divide.

Yet there are telling examples of the path we have…For instance, when the USA economy was recently confronted by the devastating effects of Hurricanes Katrina and Rita, as well as the Iraq war, their Central Bank stepped in and injected life-boat schemes in the form of billions of dollars that were printed and pumped into the American economy.

….the USA economy confronted a severe mortgage crisis… The USA Central Bank again responded by injecting over US$160 billion between December, 2007 and March, 2008…. leading central banks in the global economy are bailing out troubled economic sectors to achieve macroeconomic and financial stability….the Bank of England… providing a £50 billion lifeline to the UK’s banking sector.

Here in Zimbabwe we had our near-bank failures a few years ago and we responded by providing the affected Banks with the Troubled Bank Fund (TBF) for which we were heavily criticized even by some multi-lateral institutions who today are silent when the Central Banks of UK and USA are going the same way and doing the same thing under very similar circumstances thereby continuing the unfortunate hypocrisy that what’s good for goose is not good for the gander….

As Monetary Authorities, we commend those of our peers, the world over, who have now seen the light on the need for the adoption of flexible and practical interventions and support to key sectors of the economy when faced with unusual circumstances.