Stimulus

Yes, QE2 Is Uncharted Territory

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In yesterday's Wall Street Journal, former Fed vice chairman Alan Blinder argued that QE2, the Fed's recent decision to buy $600 billion in bonds with newly created money, may not be terribly effective as stimulus, but is neither unprecedented nor particularly worrisome from an inflationary perspective. His basic argument was that the Fed buys bonds all the time and that unmanageable inflation isn't likely because current Fed Chairman Ben Bernanke probably won't be so inept as to let prices spin out of control. I'm always wary of the argument that we should put our faith in expert policymakers. But economists on both sides of the ideological spectrum disagree on the potential negative effects of the policy, so I recognize there's some room for disagreement on this front. Still, I think Blinder significantly underplayed the novelty of the Fed's decision, which a straight-news article in The Washington Post actually labeled "risky and untested." Indeed, I suspect the novelty of the Fed's move is part of the reason why expert reaction is so varied. Writing for the online think tank e21, Former Treasury official David Malpass has a helpful response to Blinder explaning why QE2 puts the Fed in uncharted territory:  

Unfortunately, Dr. Blinder colors the debate at the outset, terming critics of the Federal Reserve "the economic equivalent of the Flat Earth Society" even though the Fed has suffered severe monetary and regulatory policy blunders over the years. Even after the housing bubble related to super-low Fed interest rates, the Fed has done little to rebuild confidence in its policy judgments.

In a garden variety monetary policy, the Fed owns short-term assets like Treasury bills, balanced by short-term borrowings from banks. Because the maturites are matched, interest rate increases would have little impact on the Fed's earnings or net worth. This assures the Fed a great deal of latitude in pursuing price stability, giving investors confidence that the Fed can sell Treasury bills and allow interest rates to rise as needed without itself losing money.

By buying longer term assets, whose value will decline when interest rates rise, the Fed is engineering a fundamental change in the nature of U.S. monetary policy. This has undercut global confidence in the Fed, as reflected in high gold prices, dollar weakness, and large-scale investments abroad by U.S. companies and wealthy individuals.

My look at the workings of QE2 here.

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  1. “His basic argument was that the Fed buys bonds all the time and that unmanageable inflation isn’t likely because current Fed Chairman Ben Bernanke isn’t likely to be so inept as to let inflation spin out of control.”

    Translation:

    “Trust us, we noes whats we doesing.”

    1. People who are “deemed” so highfalutin expert that they can experiment with the whole damn country should be willing to put themselves on the line. That is, agree to objective assessment of the results of their implemented policy, and if it fails — well, there’s asset forfeiture for a start.

  2. It doesn’t matter how many times this is explained to me, every time one of these stories come up the first thing that comes to my mind is, “What the fuck does Mrs Mountbatten-Windsor have to do with all of this?”

    Either that or the formerly grand ocean liner.

    1. You mean Mrs. Mountbatten-Saxe-Coburg-Gotha?

      I had the same reaction.

  3. 30 Year Treasury Bond yeilds are up .5% in the last 30 days.

  4. >current Fed Chairman Ben Bernanke probably won’t be so inept as to let prices spin out of control

    Am I the only one in the universe that has a painful memory of how that is done?

  5. “Unfortunately, Dr. Blinder colors the debate at the outset, terming critics of the Federal Reserve ‘the economic equivalent of the Flat Earth Society'[…]

    “All you Fed deniers are nothing more than Flat Earthers! The science is settled!”

    […] even though the Fed has suffered severe monetary and regulatory policy blunders over the years. Even after the housing bubble related to super-low Fed interest rates, the Fed has done little to rebuild confidence in its policy judgments.

    The author is being too kind – only the really ignorant of economics and the charlatans ever trusted the Fed’s policy judgments.

    From Eric Margoli’s piece today in LewRockwell.com:

    China Scorns US Funny-Money

    Washington is flooding financial markets with $600 billion of worthless dollars, hoping a rising tide of Monopoly money will somehow lift America out of recession. The Fed’s first QE effort was a fizzle. Welcome to QE2. In high finance, hope springs eternal.

    The US government is stoking worldwide inflation in order to lower its outstanding debt by repaying creditors with depreciated dollars. The rest of the world is boiling angry at Washington.

    Just before last week’s G20 economic summit in South Korea, China’s state credit agency publicly downgraded America’s credit rating and questioned US leadership of the world’s economy.

    In an unprecedented, stinging rebuke, China scolded Washington for “deteriorating debt repayment capability,” and predicted quantitative easing would lead to “fundamentally lowering the national solvency.”

    “And then there were none…”

    It is clear that QE2 is the TACIT recognition that the USGov cannot repay its debt. The USGov is clearly using inflation as a way to renege from its commitments. Let’s see if the Chinese are willing to keep playing the game with the deadbeat.

    Also, get ready for Latin American country-like inflation in the US. I am sure people the likes of Tony and Chad will blame the free market for it.

    1. I am even more certain that the opinions of Chad and Tony will not matter or be any more fluent with reality than they are now which is none and not in the least. If you didn’t sprawl a veritable scroll of post and counter post every time they display their willful ignorance they would go away. No, it would not be boring around here without the ‘diversity of opinion’; those two are what gives these threads a repetitive dullness, a feeling of ‘been there, done that’ due to so many going after the low hanging fruit of their shitty argumentation.

      Does reading James Grant ever become boring due to a lack of ‘diversity of opinion’ in he newsletters? No, because his mind is interesting and the events of the world never stop giving him analogies useful for showing the logic and purpose of his thought.

      When you engage those two in debate you hobble your argument by tailoring it to the mentality of those two dullards. I would like to see some stretching of the noggin muscles some day. Just as an example the classic Broken Windows Fallacy. If you ask me it does not go nearly far enough in showing how difficult it is to overcome opportunity cost. That is a discussion I would like to see some day, but if you are constantly arguing with Tony over the most basic principles, the discussion goes nowhere. Which is likely his purpose for posting here, thus he wins even when he loses.

      1. Of course he is on our payroll. You think it mere coincidence Tony showed up at the end of January of 2009? Of course, he is here to stifle debate and keep you busy going around in circles to prevent you extremist from thinking through another Oklahoma City scenario. That is what you Ron Paul Bumpersticker lumpkins do when you have too much free time on your hands, right?

  6. In other “BAD IDEA JEANS” news, China is imposing price controls on food.

    1. OK then. More food for us! At least something is going well.

  7. “even though the Fed has suffered severe monetary and regulatory policy blunders over the years”

    even though the Fed has suffered severe monetary and regulatory policy blunders EVER SINCE IT WAS CREATED

    There, fixed it for ya.

    1. Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.

  8. seriously, the problem is that the Fed is buying stuff that is worth far less than what they paid for it. I’m sorry, but pets.com is not coming back, and neither is most of the MBS the Fed is backing. What happens when the Fed has to report that it lost a trillion dollars?
    Fake question – it will never report that it lost money, extend and pretend continues, and JapanII (i.e., the USA) will continue.

  9. I have yet to see any believable claim that, with QE2, the Fed is doing anything other than monetizing the debt.

  10. This is definitely in the school of, “all I have is a hammer and I have to do something!”

    What pissed me off about that article was Blinder kicking the anti-Keynesians without mentioning that the big gun in the Keynesian arsenal (fed funds rate) was offline because the Keynesians didn’t follow their own model. If the rate had been 4-5% in 2006 like it should have been, the Fed might have been able to effectively intervene. Or they might not have had to because there wouldn’t have been as much imaginary money chasing around.

    The article was nothing but a legacy protection exercise.

    1. If the rate had been 4-5% in 2006 like it should have been, the Fed might have been able to effectively intervene.

      I said that the rate should be near 0%.

  11. We don’t need an independent Fed, we need a flowchart for Fed decisions that we follow in good times and bad, we need an “automaton Fed.”

    1. Again, it comes down to big risk and little to gain…

      When the 10 year note’s down to 2.95%, how much lower is it supposed to go?

      If they’re trying to stimulate job growth? Very few of the jobs the American workforce is trained for involve exports, and that isn’t about to change over the course of a few quarters.

      So they’re helping unionized manufacturers and the ag industry–industries well connected politically to Obama’s Democrats, definitely, but it’s not like all those discouraged, unemployed people are about to get jobs working as unionized manufacturing labor or in agricultural work.

      In other words, if this is all about creating jobs–which is what it is–they’re trying to create them from a pool of unemployed people who aren’t suited to the jobs their policies would stimulate growth in anyway.

      Before the G-20, Geithner was talking about reshaping the world economy so it wasn’t so heavily dependent on the American consumer–let’s not let the Obama Adminsitration (and Bernanke) trick us into the thinking that it was a problem when the world was dependent on the American consumer…

      Those were good days. Our economy went south when the American consumer went away–economic policy should be focused on bringing consumer confidence back…

      …not trying to drive the value of the currency down for job growth in export industries that 90% of the unemployed out there will never be suited to work in anyway.

    2. This is the dumbest fucking thing I’ve ever heard. They’ve already got a flowchart for it, it’s called “Keynesian economics”, and it’s a complete failure just like every other planned economy.

    3. Ya, and the flow chart looks like this:

      1) If citizen wants to convert gold to dollars, do that, at fixed rate, plus a 1% transaction fee.

      2) If citizen wants to convert dollars to gold, do that, at a fixed rate, plus a 1% transaction fee.

      3) If treasury department wants to change the fixed rate, tell them to fuck off.

      4) If fractional reserve banks become illiquid or insolvent, tell them to try a little less leverage next time. And also tell them to fuck off.

  12. it’s not like all those discouraged, unemployed people are about to get jobs working as unionized manufacturing labor or in agricultural work.

    Are you trying to tell me American steel mills can’t underprice the Koreans and take away market share?

    1. I’m saying we spent three decades or more getting away from being a manufacturing economy–and even if it were possible for average Americans to take on Korean labor and make a decent living–we’re not trained for that work anymore.

      Could we transition again? Over time, sure!

      But that’s an economy where people get married right out of high school. Most Americans just aren’t set up for that mentality anymore…

      I say that as someone who worked my way through boarding school by taking a job in a saw mill and working on local farms…

      The people I worked with before they were laid off–who used to be mortgage brokers, real estate agents and loan officers, etc?

      They aren’t about to reenter the job force working in agriculture or manufacturing. Their comparative advantage isn’t in doing exactly what they’re told and repetitive tasks.

      I don’t know what Bernanke’s motivations are anymore, but from the bailouts of GM and Chrysler on, it seems to me that Obama (and Geithner) are working for Obama’s Ag interests and the unionized labor that put him in office from Chicago all the way to the White House.

      …and it’s got nothing to do with the kinds of jobs most people are thinking of. This stimulus may not work as intended (and early returns suggest it’s backfiring*), but even if it does?

      Weakening the dollar to spur exports isn’t about to create the kinds of jobs most unemployed middle class people think of as middle class jobs.

      1. *Speaking of “backfiring”…

        “Bond Market Defies Fed”
        Interest Rates Rise Despite Launch of Treasury Buying as Investors Take Profits

        Bucking the Federal Reserve’s efforts to push interest rates lower, investors are selling off U.S. government debt, driving rates in many cases to their highest levels in more than three months.

        The Fed’s $600 billion program to buy Treasury bonds began late last week and is kicking into high gear this week, with the central bank buying up tens of billions of dollars of debt.

        Bucking the Fed’s efforts to push down interest rates, investors are selling off U.S. Treasurys, driving some rates to their highest levels in months.

        That should have driven prices up on those bonds and lowered their interest rates, or yields, which move opposite to the price. Instead, yields on almost every Treasury have been rising.

        http://online.wsj.com/article/…..75884.html

        Add to that observation (from today) that 1) after the G-20, China announced that it would buy a stake in GM’s IPO (something that most people think needs to go well in order for Obama to get reelected), and 2) that word around the campfire elsewhere today has it that China is about to raise its interest rate!

        …and then it starts to look like this is all about purposely weakening the dollar to help unionized manufacturers specifically.

        Nobody comes out and says they want to weaken their own currency–that would tick off the voters. Why would anybody in the White House come out and say they wanted to do that?

        But if you watch what they’re doing. This is what they’re doing! They’re saying things like that they want to reorganize the world economy so it isn’t so dependent on American consumers–but what that means in reality is that they want to boost American exports, presumably, to stimulate job growth. …by cheapening the currency.

  13. So, his name is actually Blinder? Huh.

  14. I’ve said it before, and I’ll say it again. QE2 will only very briefly lead to inflation. Rises in commodity prices will trigger austerity and default in the general populace. We’ll be in for a year or two of deflation, and when private debt comes to under ~2x of public debt, that’s when the inflationary cycle will kick in.

  15. Interest Rates Rise Despite Launch of Treasury Buying as Investors Take Profits

    That sounds to me as if some of the players are beginning to think the music is about to stop, and don’t want to get caught without a chair.

  16. I’d love to get in there and short Treasuries, but I don’t have that kind of money; the market Fed can stay irrational a whole lot longer than I can stay solvent.

  17. Suderman:

    Did you understand what you quoted?

    The Fed’s policy is uncharted because the Fed may not make much profit to turn over to Congress?

  18. Quantity has a quality all its own. What makes the Fed’s policy unprecedented is the sheer size of the asset purchases it is making (as well as the maturity of those purchases, in the case of long bonds, and their quality, in the case of the MBS).

  19. What is it about stories that feature the Fed that encourages H&R visitors to post such long posts? Maybe it is a guilty pleasure . . .

    1. Actually? That’s the condensed version.

      It’s in my nature…

      Libertarians talking about what they think should make for longer posts. We all pretty much agree on the whats–it’s the whys.

      1. If I’m wrong, I’m hopin’ somebody will tell me why.

        I used to learn a lot around here that way.

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