Stimulus, to infinity and beyond

Ben Bernanke

Fed Chairman Ben Bernanke

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.

Increasing frustration

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.

Impatient policymakers

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.




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  1. Huge Fan says

    It really has started to get funny (in a disgusting way) just how many people, even “educated” people, are completely clueless about how the Fed basically has no idea what it’s doing. They are the experts after all are they not? They wouldn’t be in power if they didn’t know what they were doing correct?

    In the end these clueless bystanders who just swallow increased government intervention will be the ones paying for it all.

  2. bill says

    Very helpful summing-up Detlev.
    Martin Armstrong has been saying that there is no way of knowing if those selling bonds to the Fed in such programs are Americans or Foreigners and that while buying Agencies is better than buying Treasuries,it would have been better had the Fed said last Thursday that it would buy directly from Fanny/ a more direct form of ‘stimulus’.
    Do you agree?

    • says

      No, Bill, I do not agree. I think the Fed should not do anything. Simply stop printing money and keep the monetary base stable. That would be a start. — What would be the benefit of buying directly from Fannie and Freddie? Another state subsidy for these monstrous nationalized agencies? To free up their balance sheets so they can extend more subsidized mortgages? Fannie and Freddie are representative of everything that’s wrong with the US financial system. They were instrumental in causing the housing bubble and the crisis. They should be liquidated, or at least privatized and any state support removed from them. The economy will not return to stability, sanity and balance unless we stop all this fiddling around with asset prices and interest rates. — I was told that Ludwig von Mises was once asked, Dr. Mises, are you really only advocating that the state does nothing? To which Mises allegedly answered, no, I am advocating that the state does nothing SOONER. — My point exactly!

      • bill says

        Deeply appreciate your attending my query — and that of others.You are very kind: which is virtuous and admirable and rarely seen nowadays.
        If I may be permitted a follow-up,and without reiterating my earlier point about the Fed buying US bonds owned by foreigners and sending funds overseas ( which return to USA in real time,per Rueff),is it not true that were the objective to defer a general collapse then –however foolish it may be– one would want outstanding credit to keep expanding? By productive investment ideally but in any event expanding at all costs. This is Richard Duncan’s thesis — better dead tomorrow than dead today.

        • says

          Politicians and central bankers want to expand credit at all cost. That is what central banks are there for, and they will continue to do it and get ever more aggressive about it. “In the long run we are all dead” is an extremely cynical statement – and not quite true. Some of us want to preserve a functioning economy that delivers high (and rising) living standards for our children and grandchildren. Those who distort markets ever more, print ever more money, and increase the debt pile ever more, do not care what comes after them. “Not on my watch” is the guiding principle of our politicians. The choice is not between dead today or dead tomorrow, but between making painful adjustments now or postponing them till later, and thus making them much much more painful. And later can arrive pretty soon. There is a point beyond which you may not be able to postpone the adjustment any more.
          – Richard Duncan’s thesis has come up in a couple of discussions recently. I have to admit that I have not read his recent book, so I will be careful with what I say. Nevertheless, a number of people have given me the gist of his argument and those accounts have been fairly consistent. It appears that Duncan agrees with the ‘Austrian’ analysis of how we got here but then expresses the hope that we can get out if by using cheap credit wisely, namely for productive investment. If this is indeed his argument, then I think it is politically naive and economically wrong. Naive, because does he really believe that policymakers can channel all this investment into ‘productive investment’, that politicians can identify how to use capital efficiently and productively? Is that not the role of the entrepreneur and of free and competitive markets? It is economically wrong because the excessive credit creation is in itself already the imbalance. That is already the problem. Artificially low interest rates and investment activity that is not supported by savings activity – that already spells ‘misallocation of capital’, and it cannot be made “good” by channeling credit this way or that way.

  3. graham wood says

    Detlev. Thanks for your comments and analysis of the Fed’s policies, and incidentally other governments pursuing the same ‘stimulus’ strategies.
    I am not an economist, and like I suppose millions of other bemused onlookers at the world’s financial landscape, seek to understand what is going on.
    Your analysis of QE and its repurcussions is therefore both interesting and enlightening, providing some basic insights into why governments act as they do. (our government in the UK is I believe working broadly along the same lines as the Fed and US government)
    It is the fact that QE is direct government intervention over and above normal market forces which is so disturbing, producing dislocation and distortion where markets should operate freely. Thanks for the comments and please keep them coming. Much appreciated!

  4. Rafael Wagner says

    Detlev, thank you for this terrific update on QE3 and your great insights on the gold standard issues.

    Your theories on money creation sound very logical and convincing. In our contemporary situation, it appears that the Fed’s money creation is not transmitting so effectively however. The consumer has lost his appetite for borrowing (the savings rate is up sharply) and the commercial banks are parking reserves at the Fed, so loan growth is weak. This spells trouble for an economic system that has expanded in that last 40 yrs on credit, not savings. I find it difficult to then understand that the Fed really believes a further compression of borrowing costs can make a difference. And even if some asset prices are distorted by this open-ended commitment to aggressively expand the money supply, if the consumer doesn’t take-up the cheap credit, can there be a broad and material rise in price inflation? I have read your excellent book and many posts, but would appreciate your clarification of this if possible. Thank you, R

    • says

      Rafael, what you describe is the reason why even unprecedented policy accommodation has not given us much higher inflation yet. You are correct that many sectors – consumers but also businesses – are not taking up the free cash. But the government is. It is the public sector that provides an important transmission mechanism here. The central bank prints the money and the state spends it. This will not only continue but – in my view – grow and intensify. What else can they do? As I pointed out, policymakers are no longer contend with avoiding banking collapse and a deflationary correction (which is needed but avoided at all cost by policymakers). They are using QE to generate growth. But even with the policy stance that is already in place today we have experienced continuous broader monetary expansion and continuous inflation, albeit both at reasonably moderate but meaningful rates. QE will continue and become bigger, and the Fed will at some point stop paying interest on deposits at the Fed. Then more of the excess reserve will begin circulating.

      But the most important point is not the precise quantity of money that is circulating, or how much borrowing and spending occurs in aggregate, but it is confidence and expectations. Persistent inflation – even if it is fairly moderate – will cause the public to ask for higher interest rates at some stage. I think the risk of that happening is considerable, and this risk will rise with any rise in inflation – which becomes more probable with the expansion of QE and the policies I mentioned above. At the same time, deficits continue and the public debt pile grows. If the public ditches bonds because it fears persistent inflation or even persistently growing inflation, or because the public gets nervous about sovereign solvency, then rates/yields will shoot up. So will the velocity of money, which in itself will lead to higher headline inflation. When money becomes a hot potato, inflation will rise – even without any changes to the presently circulating quantity of money! At this point, in order to restore confidence, the central bank would have to tighten policy aggressively. This means, stop printing money, maybe even selling many assets, and establishing positive real interest rates. This would conflict with the central bank’s current policy of keeping everybody afloat. Tightening would certainly lead to wider deficits and ultimately sovereign default, and it would pull the rug from under the financial system. This is why I keep saying that the central banks are digging themselves an ever deeper hole with their present policies. So in the event of a marked rise in yields in financial markets, the central bank would likely not tighten but start buying even larger amounts of bonds instead, in order to suppress yields again, as the system – banks and state- cannot cope with higher yields. But this will undermine confidence further as it involves more money printing. The public will only try to get rid of cash and bonds faster. Once confidence in the solvency of the state and the stability of paper money’s purchasing power is seriously damaged, the present policies will become self-defeating. Then things can unravel quickly.

  5. Ed Murray says

    I read your book and it makes a great deal of sense, primarily because you build a logical and theoretical case with historical evidence. When you get to the final chapter on plausible endgames and a likely scenario that seems to logically follow; the result is not good news for any asset class. I read in a response that you don’t like to give investment advice and I understand your position but you allude to prudent man returning to gold in spite of it being a “negative carry trade.” This “caution” related to the endgame is also apparent in your response to Rafael Wagner. Hypothetically, given that you see the endgame coming in 3 – 5 years or so; how would you prepare based on your economic understanding?

    • says

      Ed, this comes with my usual disclaimer: This website and all my commentary is not investment advice but economic analysis and opinion. It is entirely up to you, the reader, to what extent you share my views – which are unconventional – and to what degree you make them the basis of your own investment and/or life style decisions. The risks (and the potential rewards) are entirely yours. — Based on my analysis, I consider it prudent to hold a reasonably large allocation to physical gold (and/or silver, although I personally prefer gold). The risks of a hyperinflationary endgame are considerable, and whenever paper money dies, the eternal forms of money – gold and silver – enjoy a revival. Gold is already partially being re-monetized, in particular as a store of value. Gold offers you a bit of internal capital flight: You pull assets out of the system, out of the paper money economy, out of the banking system and out of (inflated) financial assets, but you don’t invest in investment goods or consumption goods. You still hold a monetary asset but one that is not somebody else’s liability (such as a bank deposit – and most banks are now on constant life support from the central banks) or paper money that can be and is being printed like confetti. By holding a monetary asset, a form of money, you are on the sidelines, protecting your wealth (remember, however, that gold is not cheap, that its price can be volatile and that there is no such thing as complete security), and you can wait and see how things pan out. Gold allows you to do that without all the obvious drawbacks of paper notes and bank deposits. If there is no inflationary endgame, which means the central banks stop their mad policies voluntarily and establish sound money again, we will face a meaningful deflationary correction, which will most certainly involve sovereign bankruptcies, bank collapses and massive price corrections in most asset markets. Even then, gold is a good place to be to preserve wealth. And remember: this is what it is all about: Preserving wealth.
      Personally, I don’t like bonds at all, certainly not government bonds but not even corporate bonds. Bond investors are sitting on a gigantic powder keg, and the risk premium they are getting for doing so is miniscule (and artificially depressed by policymakers). I stay away from fixed income markets completely. I don’t like equities either. Theoretically, they could do better but which equities do you want to buy? I think almost all financial assets are massively inflated. The same is true for most real estate. Remember, we had almost 40 years of uninterrupted artificially cheapened credit. (Real estate also ties you in with the local taxman. Taxing real estate is easy and potentially very lucrative for bankrupt states.)
      The biggest risk to your wealth – even if you hold it in the form of gold – comes from the state and policy, not from the economy. The recession has already created a massive anti-wealth sentiment. This will stay in place, probably grow, and is likely to drive policy for years to come. Think about where you want to hold your wealth (gold), which country you would want to live in yourself, and, if at all possible, what citizenship you would like to have before they shut the doors to you and your assets. We will most certainly see more onerous taxation and regulation, as well as capital controls in some shape or form. Wealth-holders should start thinking like a persecuted minority, which is what they already are in most jurisdictions, and what they will become in most of the rest of the world. That is my personal view. More in a post to be published soon.

      • Ed Murray says

        Detlev, I really appreciate your insight and it seems very consistent with your book but it is very clearly stated in unequivocal terms. Of course any “action” is contrary to any of the standard options that have been available for the last 3 decades but I must agree with your prognosis. It’s sad to watch the demise of one’s country but I’m afraid those who don’t act will not like what happens in the near future. Thanks.

  6. Rafael Wagner says

    Thank you Detlev for your response and the further commentary. I look forward to your future posts. Best of luck with your book prize nomination – I haven’t read the others but your’s is top notch.

  7. VT says

    I just realized that reading this site is actully mentally healing because reading all the time in mass media about only the virtues of money printing is driving me crazy! You are truly one of few sane words in this insane world.

    For me, there are so many things that drives me crazy when central bankers justifies why they must do actions. Here is one:
    Bernanke argued that they must start QE3 because the unemployment is too high and they want to lower it. Ok, if that is just that easy, why they waited 4 years to lower it! Why they just didn’t printed enough money in the first place and all would be well!! Detlev, do you think that they really believe themselves what they are saying? I think you partly answered already in your writing as you said that the central bankers are starting to get desperate of their actions. Maybe, just maybe they are starting to lose their faith..?

    • says

      Difficult to say. I would guess that at least some of these central bankers must have their doubts by now but I think those are very much in the minority. On balance, these people believe 100 percent that they are doing the right thing. Remember, these people built their entire careers on their established belief systems (e.g. the central bank is needed and a source of stability, it can always generate growth through money-printing; the only downside is the risk of inflation and we have plenty of time to address that later….). They are not going to give up those beliefs now when they reached the pinnacle of their careers and have finally the hand on the monetary levers and can now put to practice what they thought all those years. Also, they operate in an institutional setting – with their central banker colleagues and sympathetic academics – that reinforces these beliefs. Like all good bureaucrats, the central bankers will print money to the bitter end.


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