I was just having an argument/debate about quantitative easing. Marshall Auerback, Randy Wray and I all have posts here at Credit Writedowns which explain that quantitative easing does not create new net financial assets and is merely an asset swap which has no direct effect on the real economy. Nevertheless, there is a vast difference in the terminology we use to describe these matters.
Why is that? Much of this has to do with Economic Code Words and the neo-liberal orthodoxy which has controlled the economics profession for the past generation. This orthodoxy is the one responsible for the increasing reliance of the US economy on the financial sector as anti-regulatory and pro-incumbent business policies gained sway ideologically. The result has been a leveraging up in the U.S. in a way that has benefitted the more well-to-do than average Americans and a financial system which is extremely prone to systemic crises.
I will get back to this shortly. First, let me say that from a technical perspective, quantitative easing involves the creation by the Federal Reserve of ‘electronic dollar credits’ to purchase Treasury securities in much the same way the Federal Reserve operates when defending the Fed Funds rate (see here for a discussion of the Fed Funds process). This is an asset swap that does not create net financial assets because the bonds have now been replaced by the dollar credits. When interest rates are effectively zero percent, this is the asset swap equivalent of issuing treasury bills to replace whatever the Fed has just purchased (see On Liquidity Traps and Quantitative Easing for a more in-depth discussion). Think of this as a barter between the Federal Reserve and some bank in which the Federal Reserve finds a willing seller of financial assets for the dollar credits it has just created. It then takes those assets out of circulation when it buys them. For the financial system as a whole, the monetary base has expanded (reserves are up) but net net, financial assets have not.
And remember, this is not credit easing. Bernanke said QE1 was an exercise in ‘qualitative easing’ whereby the Fed became the lender of last resort during a liquidity crisis in which no one would accept many financial assets at any price. That is its legitimate role as a central bank. My problem with the Fed’s balance sheet expansion is what you would hear from anyone who has a visceral negative reaction to central planning: the expansion is the product of centralized planning. I can understand temporarily lending during a liquidity crisis at a penalty rate. But the Fed never lent against good assets at a penalty rate during the crisis. It bought dodgy assets at inflated prices, making it difficult to discern which firms were illiquid and which were insolvent. Clearly, this was its intention. This enabled insolvent companies to masquerade as solvent while the economy went through terrible unemployment and recession. The Fed, thus, transferred risk onto the taxpayer without any oversight because it refused all FOIA requests and now its balance sheet is four times the size it was just two years ago. Yet, they now want to do more. It makes no sense to anyone except those who are already predisposed to activist government. This is exactly why is everybody in an uproar about QE2.
But QE will not work because the demand for credit by creditworthy borrowers is not going to increase in a balance sheet recession where household income is stagnant and most are already stuffed to the gills with debt mortgaged against declining house prices. That is an environment in which the Fed will be pushing on a string and any liquidity will simply add to speculative excess both in the US and elsewhere. Many, including the Fed Chairman, will tell you that creating reserves actually gives banks loanable funds which can jumpstart the economy. This is clearly false as we already have $2 trillion in excess loanable funds on offer. QE is not about the real economy but animal spirits and leverage. It is a massive pump and dump. And savvy investors like Jeremy Grantham have already begun to sell.
But, here’s where the MMT’ers and I disagree. This whole song and dance about QE not being inflationary misses the point. QE is about asset prices. The true believers – retail customers and the inflationistas – may not be on to the pump and dump here – but guys like David Tepper know that this dash for trash has a sell by date and they will be out of risk assets in due course. Ordinary Americans will be left holding the bag when the economy relapses. Moreover, as commodities have been financialized, you can already see the pass through of the (temporary) asset price inflation into commodity prices in the US and around the world.
The layman sees the Fed’s balance sheet expanding, banks making lots of money, but credit growth subdued, unemployment high, etc, etc and the only conclusion one can draw is that the Fed is printing a bunch of money and handing it out to their cronies on Wall Street. That’s what people in America are thinking. And, of course, there is some truth to this. So, at a minimum, politically, this is radioactive. And that’s why the Quantitative Easing Explained video has hit a nerve – despite some technical inaccuracies (the Fed cannot buy bonds directly from the Treasury in order to maintain the Fed’s independence, for example).
That leads me to the economic code words:
- printing money
- debasing the currency
- banana republic
- fiscal profligacy
These are all the things you would hear from those who have actually benefitted from the neoliberal orthodoxy which created America’s problems to begin with. But you will hear these same words from people who are uncomfortable with the easy money and debt accumulation like me too. I prefer this terminology because that’s how I think of the matter – and that’s how most people do too. But these words have an ideological taint to them. And I got into some of this in my hyperinflation post (emphasis added).
What about the ideology? Well, the MMT’ers say that the Austrian ideologues and the gold fetishists have a deflationary bias when inflation doesn’t change the real productive capacity of a nation. Clearly, the hyperinflation talk is a gimmick with which to discourage deficit spending. You should see this debate as about a specific policy prescription driven by ideology. The other side of this ideological divide was taken up by Dean Baker in the Guardian’s “Cliches won’t fix the financial crisis“
Nevertheless, inflation does alter business decision-making via accounting’s tie to nominal numbers and the money illusion. Moreover, inflation reduces relative wealth by transferring income from those who receive the money first like banks versus those who receive their money later, your typical widow living on fixed income bonds and annuities. Finally, inflation encourages the accumulation of debt by benefitting borrowers over savers. I see inflation as a problem to be avoided.
Ideologically then, I see inflation as the increase in the money supply.
Economics. an increase in the VOLUME of money, which eventually leads to a persistent, substantial rise in the general level of prices and results in the loss of value of currency.
-What is Inflation?, Credit Writedowns, June 2008
And where inflating the money supply does not eventually lead to consumer price increases, it does lead to asset price increases which foster a stronger boom-bust tendency.
So, people like me look at large government deficits in a fiat currency system as an invitation to print money and inflate the money supply. If you take this way of thinking to a logical extreme, you end up with what Marc Faber is talking about: hyper-inflation.
But, this is ideology – not economics.
I am not going to be cowed into using some PC way of talking about the Fed’s balance sheet expansion and its creation of electronic dollar credits. To me – and to any reasonable layperson – this is printing money, plain and simple. It’s a shambolic farce – even more so because it won’t do anything for the real economy except via animal spirits and leverage. Yes, it is the Bureau of Engraving & Printing in the Treasury Department which actually prints dollars. But, clearly the Fed’s creating previously non-existent dollar credits is as close to the average person’s definition of plucking money from a money tree as you’re going to get.
And while the Fed is not going to be successful in debasing the currency because QE is just an asset swap, it is clearly trying to do so. At a minimum, it is creating currency revulsion and this will end the dollar standard rather sooner than later. The Fed has this wrong. They are ruining any shred of credibility they have on a monetary policy that does not work except via asset markets. Bernanke knows this too. It’s the ultimate financialization Ponzi response to a financialized debt-ridden American economy. It is an attempt to debase the currency and drive up asset price inflation. It is a tax on ordinary people who do not benefit from this asset price inflation in a world where real wages are stagnant or declining. It fosters a surreptitious transfer of wealth to the most wealthy. Other than that, it’s just fine.
The fact is America ran up too many private sector debts and ran aground as a result. President Obama attempted to fix the problem in part by focusing on fiscal stimulus – which in my view is clearly more effective than money printing. But his policy response has been ineffective for reasons I don’t have the space to get into here. Read "The Origins of the Next Crisis" for the in-depth view, if you’re interested.
Now, people are asking themselves: "what next?" And so Bernanke starts up the QE – AGAIN. Are you surprised that people are outraged, with underemployment at 17% 3 years after a deep recession first began?
Update: I should add this commentary as well; it seems to me that ideological divides have increased rather than decreased of late – and QE2 has been front and centre in this. I have also seen it in the foreclosure crisis coverage. In my view the return to one’s ‘ideological home base’ is the outgrowth of the length of the economic crisis. It goes to basic human psychology and fear. Fear is starting to grip people again after a brief period of technical recovery. Given the uncertainty that our inability to crack this crisis has engendered, fear is the emotion that now comes stirring up – and that leads to ideological rigidity.
If policy makers had been successful in fixing things, we would have had less polarization than we do now. When I read various blogs these days I see fewer nuances with a narrowing of views, a reduction in links to non-ideologically aligned blogs, and more one-sided rhetorical positioning. It’s as if bloggers are saying, "I am going to play to win" the ideological debates this crisis has spawned. I refuse to take that route. And I know some others I have talked to about this are also trying to guard against this as well. But these divides are increasing in the blogosphere, nonetheless, just as they are in the political world both in the US, in Europe and internationally.