Quantitative Easing II

[p-branez]

A primer here:

http://blogs.wsj.com/economics/2010/11/03/qa-on-qe2-what-a-fed-move-would-mean/

here's what I could remember from my international finance class (still angry i sold the book on Amazon for something like $3.50.) please fill in where needed.

Issues about the Fed move:

1. Doing an Open Market Operation. Buying Treasury bonds puts cash into the hands of banks.*
2. This is normal for the Fed since 2007. The Fed already owns $700B of Treasury bonds and will add $600B gradually until mid-2011.
3. Banks lend more & cheaper money. People buy/refinance homes, cars, and businesses invest.
4. Quantity Theory of Money – putting more money in the economy will, in the long run, increase inflation
5. Increases in inflation, or even expected inflation, erode the relative value of our currency
6. Depreciated currency means US exports are relatively CHEAP, and imports are relatively DEAR
7. US exports increase, imports decrease. GDP = C + I + G + (EX-IM) Ceterus paribus, GDP increases

* Assumption: increasing the reserves of banks will finally get them to start lending.

There are two main fears brought on by this action. First, domestic inflation is worrying. But inflation has been running too low for too long, and economies are best suited to run around 2% inflation. Second, and more importantly, the devaluation of our currency will come at the expense of our trading partners. One of those trading partners is China, whom American politicians constantly bash for artificially devaluating their currency. The truth is, both America and China do it; all countries with a managed floating exchange rate do it. But the fact that US condemnation of the value of the yuan has been so pervasive and intense, it will come as no favor to US in the upcoming G20 talks. Also, with money seeking the highest rate of return, it will arrive in Asia to inflate assets like stocks, commodities, and real estate.

What do you think? How relevant is the Fed's monetary policy when 1) we've been in a liquidity trap - near zero interest rates for two years now, and 2) all focus seems to be on fiscal policy?

[HAL 9000]

That seems pretty spot on, my understanding was slightly different around point 1. I think the government action lowers the cost of wholesale borrowing for banks (buy reducing bond uields) and this allows them to finance more lending to customers at lower rates. I think this is a slightly different issue to the large reserves that banks are building up - the reserves are capital and its function is to absorb future credit losses rather than to be a source of funding for more credit risk.

You also mention expected inflation, which raises and interesting point, as it is unexpected inflation that tends to reduce the value of money and trigger increases in employment. Expected inflation leads to compensating adjustments in currency and derivative markets that aid net exports.

Personally, I have always been suspicious of economic policies that seek to promote 'spending' as a source of economic prosperity. I cant quite put my finger on why, maybe because I think if people are saving, that means more money is available for investment in R&D (after all it is ultimatley savings that banks invest in business - thats what a bank is).

It seems to me that artificially inflating spending is a way to prop up inefficient businesses and products who could not otherwise compete - and that sounds like an approach designed to create short term jobs at the expense of long term growth (but such political point scoring is the cost of democracy).

[p-branez]

thanks for the input, HAL. You must be correct about point 1.
I wanted to bring this up because I think Americans and the media focus little on monetary policy and more on fiscal policy. I'm always working on my economic literacy. I share the same skepticisms about basing an economic recovery on consumption - it's short term gratification that does not address the underlying long term problems in our economy. Also, it's still unknown whether individuals will spend their money in consumption. When President Bush rolled out his tax rebates in 2008, the majority of individuals (I think around 65%) used the money to pay down their debt.

Here's an international perspective (gleaned from conversation with an Asian who worked in finance industry):

I don't think banks can domestically find the highest return on their money - the investment that banks are always looking for. The cheap US$ held by banks (they borrow from the Fed at near 0% interest rates) is going to flood emerging markets. At least for the time being, no other currency can compete with a cheap US$ so banks are going to open up the tap with US$ flowing into Asia and emerging markets. When Fed is done with this gradual purchase of treasury bonds, the plug will get yanked out. So US banks prop up asset bubbles - real estate and stocks - with US$ that will someday soon be worth far less than currently. Who benefits? US financial institutions - we know they are great at surviving housing bubble bursts that they help create.

It's not that much of a stretch when you think about the revolving door (http://www.portfolio.com/industry-news/banking-finance/2009/12/03/revolving-door-between-wall-street-and-government-must-be-reformed/)

[yeahwho]

So this Quantitative Easing is just like loose bowel movements?

[p-branez]

it's like a loose bowel movement that is going to overflow the bowl, increase inflation, end up in china, and make our other bowel movements (debts) in the world worth next to nothing.

check out this funny video (http://globaleconomicanalysis.blogspot.com/2010/11/qe-explained.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+MishsGlobalEconomicTrendAnaly sis+%28Mish%27s+Global+Economic+Trend+Analysis%29) for a good look at what exactly QE does and who will benefit.

And while the Fed is increasing activity in the bond market, former-Fed Chairman Alan Greenspan: (http://www.reuters.com/article/idUSTRE6AD1QX20101114)

"He said the risk is that the deficit, which hit $1.3 trillion this year, could spook the bond market. That would result in long-term interest rates moving up rapidly and could lead to a double-dip recession."

[yeahwho]

check out this funny video (http://globaleconomicanalysis.blogspot.com/2010/11/qe-explained.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+MishsGlobalEconomicTrendAnaly sis+%28Mish%27s+Global+Economic+Trend+Analysis%29) for a good look at what exactly QE does and who will benefit. "

Great video, it did have one blaring omission. As much as the cartoon acknowledges US mortgage failures over and over they forgot to mention that housing prices are incredibly low due to this. And the taxes higher than a year ago is really stretching it (http://www.usatoday.com/money/perfi/taxes/2010-05-10-taxes_N.htm). Other than that it was a nice attempt (y)

[yeahwho]

I think the real problem is being honest about the type of representation our elected officials are providing us. We as Americans have let things get so far out of hand that simple loan information and financing procedures require mathematical skills of the highest degree.

We need to confront our leaders and tell them to quit representing the superrich. As Frank Rich says today in the NYTimes (http://www.nytimes.com/2010/11/14/opinion/14rich.html?hp) and millions of others have been saying all along, quit coming after the working class to support the wealthy. We will surely die as a Country if this route is not changed within the next few years.

[p-branez]

an open letter from economists to Fed Chairman Ben Bernanke (http://blogs.wsj.com/economics/2010/11/15/open-letter-to-ben-bernanke/)

It's short, but some highlights (bold is my addition):

"The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment."

"The Fed’s purchase program has also met broad opposition from other central banks and we share their concerns that quantitative easing by the Fed is neither warranted nor helpful in addressing either U.S. or global economic problems."

When China manipulates its currency, it's called manipulation and American politicians start their round of bashing & pressure the yuan to rise in value.
When US manipulates its currency, it's called growing the global economy.

When will the US no longer be able to have it both ways?

[yeahwho]

This is a great thread and I hope more intelligent people than I continue to post here (leaving myself wide open, bent over, ready to rape there) because it is important that citizens become aware of these overly complex financial decisions.

Just the term "quantitative easing" makes me drowsy. If more light is shed on economic policies then less people will be ignorant to the ways of our common denominator here on earth, money.

I like Joesph Stiglitz quite a bit because of his take on the 2008 crash (http://www.youtube.com/watch?v=DJLsRiv0gTg)issue and subsequent bailout. I noticed he also was blurbed on on the WSJ issue you originally posted. Stiglitz to Obama: You’re Mistaken on Quantitative Easing (http://blogs.wsj.com/economics/2010/11/11/stiglitz-to-obama-youre-mistaken-on-quantitative-easing/?KEYWORDS=stiglitz)

Rather than just looser monetary policy, the Columbia University economist urges more government spending by countries whose low borrowing costs make it affordable—notably the U.S.

“We really should learn the lesson from China,” he said. “If you take money and spend it on investments, then you grow the economy in the short run, but you also grow the economy in the long run.” He says China’s massive infrastructure investments over the past two years have “changed the economic geography” of that country, setting it up for strong growth in the years ahead.

The U.S. should do the same, he said, adding that because it has funded infrastructure so poorly over the past 20 years, projects will likely have strong positive return on investment.

[p-branez]

Agreed all around. One of the reasons I like to post here is get an international (or at least a broader national) perspective on issues. Most of this thread is inspired by an Asian friend. He studied in US & lived in Europe so has a keen perspective on how Americans view the rest of the world and how the rest of the world views Americans. He believes financial literacy is lacking among Americans and that we are slow to recognize our country as just one of many players in a globalized world. We hold a strong US-centric worldview and often do not realize the international implications of our policies. Of course, these are broad generalizations of the American people, but I see the US-centric perspective everyday.

Maybe it's our politicians, maybe it's the media, maybe it's the uneducated public, maybe it's some combination of all three, but Americans focus so much on domestic issues that we lose sight of international implications. The US acts on issues - Iraq war and recent QE - that the rest of the world tells us not to do. In the case of QE2, China's inflation continues its rise, most recently to 4.4% (to put in perspective, Bernanke believes the American economy is best suited for inflation to run at 2%). Who does this hurt? The working people in China who purchase food, fuel, shelter, and basic living staples. Without comparative increases in wages, the working people will lose purchasing power and may seek redress through social unrest.

Excellent quotes from Dr. Josephn Stiglitz. My friend calls him one of the very few "economists with a conscience." I read "Globalization and Its Discontents" as both an introductory political philosophy and international economics text.

The debate about growing the US economy goes back to what Hal said. China has seen growth because of its investments in infrastructure. What we're doing now in the US is printing money to fund short-term consumption. But if we were to sacrifice now (something HAL correctly notes is politically untenable) we could more than offset the sacrifice with increased consumption in the future. This is simple macroeconomics: we save money now and invest in public schools that can perform; remove cost barriers to higher education; fund basic science research; improve transportation, energy, and communication systems; and improve access to affordable health care. These investments then prime the economy for a new round of consumption-led growth. In long-run macroeconomics, it is fine to borrow and run deficits as long as the investment is a good one.

[p-branez]

Another video of Bernanke's confusion related to "printing money," this one from Jon Stewart:

http://www.businessinsider.com/jon-stewart-ben-bernanke-2010-12

"But don't take it from me, take it from the guy with the exact same beard, on the exact same show, talking to the exact same interviewer..."