There was a beautiful symmetry to last week’s policy announcement by the Fed. Precisely a week after the ECB had pledged its commitment to unlimited purchases of Euro Zone government bonds, the Fed declared that its new round of debt monetization – ‘quantitative easing’ or QE3 – would be open-ended.
Unlimited, open-ended. The concept of stimulus has certainly evolved since the crisis started.
This should give us reason to pause. ‘Unlimited’ is not a word that is used much in economics or in business-life. The only thing that is really unlimited is peoples’ wishes and desires. Everything else is very limited indeed. That is why we have markets and prices and competitive enterprise, in short, that is why we have capitalism: to make the best use of limited resources in the face of essentially unlimited demands on such resources. The market is all about allocating scarce means to chosen ends (chosen by the consumer), all about relative prices, about trade-offs. And the beauty of private enterprise is precisely that when things go wrong the losses are private and limited. Every businessman, every investor, even every gambler, knows that sometimes you have to cut your losses if you want to survive.
Not so in politics – and now central banking – where the stop-loss limit is evidently seen as an indication of lack of commitment. “We will do whatever it takes” was a phrase that was much used in the early part of this crisis, around 2008. No doubt it was meant to instil confidence, yet it is one of the scariest things a policymaker can say. If policies go wrong – or have unintended consequences, as they always do – the costs are born by society. We should be concerned if those who are entrusted with the privileges of state power declare that they will use these powers without limits – the power to tax, the power to regulate, the power to legislate, and the power to print money. On Thursday Bernanke declared that he would not stop his policy until it has the results that he believes it should have.
The FT, a reliable cheerleader for policy-activism and firmly in the don’t-just-stand-there-do-something-anything school of crisis management, said the decision was bold. Well, maybe. But the decision for unlimited QE is also a sign of defeat. QE2 had not delivered what Bernanke had told us it would. In November 2010, in his famous Washington-Post op ed, he had expressed his view that the $600 billion he printed back then would kick off a ‘virtuous cycle’. Well, that didn’t work out, did it?
The notion behind the term ‘stimulus’ had always been the one-off kick-starter, the policy-induced ignition that would simply set the economic engine in motion again. In Paper Money Collapse I explain why this image is false and the word ‘stimulus’ misleading and why every stimulus necessarily changes the economy, why it must create winners and losers, change income distribution and resource use. Stimulus sounds harmless but every stimulus is intervention. And the iron law of intervention is that once you intervened you have to intervene again, you cannot just stop the intervention without undoing the results of previous interventions. QE is state intervention in the market. There is no natural end to it. Bernanke de facto admitted that much last week. If QE3 had been limited, it would have ended at some point, and if the economy had then not been much healthier, and that is obviously now a valid concern for the Printmaster-in-Chief, he would have had to announce QE4, and so forth. With the decision last week, Bernanke saved himself the embarrassment of adding bigger numbers to this, his last-ditch policy tool.
If QE was supposed to be a form of medicine for the economy as its advocates claim, then Bernanke conceded now that the patient, after 4 years of treatment, has not recovered but is now addicted to the medicine. “We can’t turn off the monetary morphine unless the patient gets better.”
What does ‘get better’ mean? – Bernanke says a substantially improved labour market. Well, I wonder how many Americans will find employment as a result of the various asset price manipulations that are the central bank’s stock in trade and that – mind you – were instrumental in creating the crisis in the first place. But even if we were to believe it, wouldn’t that mean that these Americans are forthwith dependent on ongoing Fed largesse? I mean if Americans find jobs that evidently depend on artificially cheap credit from the Fed, will these jobs not disappear when the artificial cheapening stops? – Oh, I forgot, there is no end to the Fed’s easy money stance. Silly me.
The Fed – like all other central banks – is increasingly boxed in. They know – or begin to suspect – that their policies are not kick-starting the economy but they cannot admit it. ‘Unlimited’ and ‘open-ended’ have a ring of machismo about them but they also indicate frustration and desperation.
We cannot say we haven’t been warned. Bernanke’s affinity for ‘unlimited money printing’ was well documented by this famous statement of his:
“The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost…We conclude that under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”
But the speech that this quote is taken from, before the National Economics Club in Washington in November 2002, was all about the risk of deflation. Today, there is no (imminent) risk of deflation in the US. And the risk of banking system collapse is, from all we know, not any bigger today than it has been at any point over the past 12 months when the Fed did not expand its balance sheet at all. I therefore agree with those analysts who say the Fed is doing something different, although I believe that this was already the case with QE2. It is not using QE as an extreme measure to avoid banking collapse or the onset of a deflationary spiral (a hugely overblown fear anyway, in my opinion) but because it is getting frustrated with the speed of growth. Avoiding the collapse of the financial house of cards has been one objective of monetary policy in recent years, but simply maintaining the financial system in a state of arrested collapse is not enough. We need growth. And the Fed has only one means of creating growth, that is, by artificially cheapening credit and massaging various asset prices up and their yields down with the help of the printing press. That is obviously the same policy that got us into the crisis in the first place but never mind.
Having said all this, there is no reason to expect any fireworks soon. Let’s be honest, in today’s world of trillion-dollar deficits $40 billion a month is not that much. At that pace, it will take the Fed until Christmas 2013 to inject the same kind of money into system that it did within 6 months during QE2, when it did not kick-start a ‘virtuous cycle’.
The Wall Street Journal reported that economists had estimated that another $500 billion of QE would boost GDP by 0.2 percent and lower the unemployment rate by 0.1 percent. Or, was it GDP by 0.1 percent and the unemployment rate by 0.2 percent? – I forgot. The Wall Street Journal did not report if the economists were sniggering.
It will take the Fed a year to get $500 billion newly printed cash into the system. I suspect the Fed economists expect a bigger impact as all the money is targeted for the mortgage market. I also think the monthly amounts will soon be lifted to more meaningful sums.
The bottom line is this: QE is no longer unconventional. It is the new normality. The central bank not only manipulates – persistently and systematically – short term interest rates and the supply of bank reserves so that credit remains constantly cheap, it now also manipulates the shape of the government yield curve, the cost of state borrowing, and risk premiums in the mortgage market. All of this requires ongoing balance sheet expansion at the Fed and open-ended money printing. And there is no exit strategy.
This will end badly.