Wednesday, November 17, 2010

Quantitative Easing

I have been meaning to write on the subject of quantitative easing (QE) for some time but have not because this is a HUGE topic and I hate getting it wrong.  But here goes...

QE is the name given to the process whereby the Fed injects money into the economy by purchasing assets like stocks and bonds.  The difference between this method and the usual method is that money is "created" without increasing debt.  As can be imagined, the investor classes hate QE because it undermines the essential rates of usury.  And so it is almost never employed and the protests are loud and organized whenever it is.

But here's the deal, mechanisms to create money without simultaneously creating debt has quite an enviable track record in stimulating economic activity.  Marriner Eccles was quite fascinated with his QE powers and used them to extricate the USA from the Great Depression and fight WW II.

Interestingly, Paul Krugman is such a fan of QE that he thinks we should be talking in terms of $10 trillion.  Since I think we should be spending in the neighborhood of $2 trillion per year to solve the problems caused by the end of the Age of Petroleum, I like it when economists talk about trillions of QE.

Then there is this take on QE from Ellen Brown.
QE2: It's the Federal Debt, Stupid!
Friday 12 November 2010
by: Ellen Brown, t r u t h o u t | News Analysis
Unlike QE1, QE2 is not about saving the banks. It's about saving the country from Greek-like austerity measures necessitated by a burgeoning federal debt. The debt is never paid, but is just rolled over from year to year; but the interest is paid, and it is here that QE2 relieves the pressure, since the Fed rebates its interest to the Treasury. 
The inflation hawks are circling, warning of the dire consequences of the Fed's new QE2 scheme. "Quantitative easing" (QE) is Fedspeak for creating money out of nothing with a computer keystroke. The hawks say QE is massively inflationary; that it is responsible for soaring commodity prices here and abroad; that QE2 won't work any better than an earlier scheme called QE1, which was less about stimulating the economy than about saving the banks; and that QE has caused the devaluation of the dollar, which is hurting foreign currencies and driving up prices abroad.
It might be argued, however - and will be argued here - that QE2 not only will NOT produce these dire effects, but that it is NOT actually about saving the banks, OR devaluing the dollar, OR saving the housing market. It is about saving the government from having to raise taxes or cut programs, and saving Americans from the austerity measures crippling the Irish and the Greeks; and for that, it could well be an effective tool. What is increasing commodity and currency prices abroad is not QE, but the US dollar carry trade; and the carry trade is the result of pressure to keep interest rates artificially low to avoid a crippling interest tab on the federal debt. QE2 can relieve that pressure by funding the debt interest free.
The debt has increased by more than 50 percent since 2006, due to a collapsed economy and the decision to bail out the banks. By the end of 2009, the debt was up to $12.3 trillion; but the interest paid on it ($383 billion) was actually less than in 2006 ($406 billion), because interest rates had been pushed to extremely low levels. Interest now eats up nearly half the government's income tax receipts, which are estimated at $899 billion for FY 2010. Of this, $414 billion will go to interest on the federal debt. Raising interest rates just by a couple of percentage points would make income taxes prohibitive.
Interest rates cannot be raised again to reasonable levels until this interest tab is reduced. And, today, that can be done most expeditiously through QE2 - "monetizing" the debt through the government's own central bank. Only its own central bank will advance credit to the government interest free. Congress also has a computer keyboard and could issue the money not just debt free but interest free, but Congress has not been so bold since the Civil War. The Fed has, therefore, had to step in. more
There are also calls from respectable folks that Europe should begin a serious program of QE.
Europe stumbles blindly towards its 1931 moment
It is the European Central Bank that should be printing money on a mass scale to purchase government debt, not the US Federal Reserve.
By Ambrose Evans-Pritchard 10:00PM GMT 14 Nov 2010
Unless the ECB takes fast and dramatic action, it risks destroying the currency it is paid to manage, and allowing a political catastrophe to unfold in Europe.
If mishandled, Ireland could all too easily become a sovereign version of Credit Anstalt - the Austrian bank that brought down the central European financial system in 1931, sent tremors through London and New York, and set off the second deeper phase of the Great Depression, the phase when politics turned ugly.
“Does the ECB understand the concept of contagion?” asked Jacques Cailloux, chief Europe economist at RBS. Three EMU countries have already been shut out of the capital markets, and footloose foreign creditors hold €2 trillion of debt securities issued by Spain, Portugal, Ireland and Greece.
“If that is not enough to worry about financial contagion, what is? The ECB's lack of action begs the question as to whether it is fulfilling its financial stability mandate,” he said. That is a polite way of putting it.
The eurozone’s fiscal fund (European Financial Stability Facility) is fatally flawed. Like Alpinistas roped together, an ever-reduced core of solvent states are supposed to carry the weight on an ever-widening group of insolvent states dangling beneath them. This lacks political credibility and may be tested to destruction if – as seems likely – Ireland is forced to ask for help. At which moment the chain-reaction begins in earnest, starting with Iberia. more

Yes but...What about the investor class?  Don't they have something to say in the matter?  Why yes, QE has set off a firestorm of criticism.  Here is a sample.
Huge List Of Investors And Economists Pen Open Letter To Ben Bernanke Slamming QE
The Pragmatic Capitalist | Nov. 15, 2010, 4:34 AM  
The Wall Street Journal ran this open letter to Ben Bernanke from many noted economists, professors and fund managers. The list is a who’s who of Wall Street and the general message is not dissimilar to what Sarah Palin and Glenn Beck (not exactly the people you want to be next to when making economic prognostications) have been saying – in essence, cease and desist Chairman Bernanke. While I agree with the general message of the letter (that QE should not be allowed to go forward) it also shows the great level of sheer misunderstanding when it comes to QE. This one policy has generated more misunderstanding than any policy measure I can remember.
Many of the people on this list have been warning about bond vigilantes while also comparing the USA to Greece for several years now. Of course, they’ve been terribly wrong and it is entirely due to the fact that they do not understand how the US monetary system works. Their general fears of inflation and a crashing dollar have been far off the mark for reasons I have discussed in great detail here. What’s unfortunate is that these are many of our best minds. These are the people driving the economic bus. It’s no wonder this country is in such an economic hole.
The full letter is attached with some commentary:
“We believe the Federal Reserve’s large-scale asset purchase plan (so-called “quantitative easing”) should be reconsidered and discontinued. We do not believe such a plan is necessary or advisable under current circumstances. The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment.” more
Krugman dismisses these cries of anguish and for good reason--you could have predicted this criticism easier than dawn.
QE Madness
It has been really interesting to watch some of the commentary over quantitative easing by the Fed: while people like me see the Fed’s actions as way too timid, there’s a substantial faction out there that sees them as the end of Western civilization. Right now the most popular story on Bloomberg is Jim Rogers saying that Bernanke doesn’t understand economics, that he’s “debasing the currency.”
I’ve seen Rogers in action; he seemed to me to be confused about issues like the difference between assets and liabilities. And please note that inflationistas like Rogers have been wrong about absolutely everything this cycle (and the last cycle, and the cycle before that).
But they have their devotees. And this means that monetary policy, our only real hope at this point, must climb a wall of stupidity. more

Of course, after 35 years of training the economic community that the only real disaster is inflation, there are those who will worry about hyperinflation in the midst of a global deflation.
David Rosenberg: All This Talk Of Inflation Is Madness, DEFLATION Is Still The Big Threat
Joe Weisenthal | Nov. 1, 2010, 5:24 PM  
Yields have come up on Treasuries, and inflation expectations are starting to widen, but longtime deflationista David Rosenberg is having none of it.
In his latest note, the Gluskin-Sheff economist continues to pound on the inflation threat:
The risk is to treat last Friday’s U.S. GDP report with a cavalier approach. There was really nothing benign about it. It is abundantly clear that the economy is in a spot of trouble. Weak exports and fiscal retrenchment mean no exogenous boosts at a time when real final sales growth is slowing and now barely positive. A chronic large gap in the labour market will result in decelerating, if not falling organic personal incomes, putting consumption at risk at a time of a rising trend in the savings rate. Indeed, real personal disposable income growth throttled back to a mere 0.5% annual rate in Q3.
Investment will be tepid, at best, in view of the high degree of excess capacity and the overall weakness in housing and commercial real estate activity. The best days of the inventory cycle are behind us. With all this in mind, one would expect the base-case scenario to be one of economic contraction and price deflation with regard to final goods and services. The New Abnormal that dots the editorial page of the weekend WSJ (A16) is well worth a read.
Notwithstanding the boomlet in commodity markets, and heightened inflation expectations in the TIPS market, curiously before the Fed has even announced anything, the economic data still support the overall notion of deflationary momentum. The personal consumption expenditure price index excluding food and energy (core PCE) came in at a tepid 0.8% annual rate last quarter and this took the YoY trend down to +1.3% from +1.7% at the turn of the year. more

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