Quantitative Easing

Posted by PITHOCRATES - June 24th, 2013

Economics 101

The Gold Standard prevented Nations from Devaluing their Currency to Keep Trade Fair

You may have heard of the great gamble the Chairman of the Federal Reserve, Ben Bernanke, has been making.  Quantitative easing (QE).  The current program being QE3.  The third round since the subprime mortgage crisis.  It’s stimulus.  Of the Keynesian variety.  And in QE3 the Federal Reserve has been ‘printing’ $85 billion each month and using it to buy financial assets on the open market.  Greatly increasing the money supply.  But why?  And how exactly is this supposed to stimulate the economy?  To understand this we need to understand monetary policy.

Keynesians hate the gold standard.  They do not like any restrictions on the government’s central bank’s ability to print money.  Which the gold standard did.  The gold standard pegged the U.S. dollar to gold.  Other central banks could exchange their dollars for gold at the exchange rate of $40/ounce.  This made international trade fair by keeping countries from devaluing their currency to gain a trade advantage.  A devalued U.S. dollar gives the purchaser a lot more weaker dollars when they exchange their stronger currency for them.  Allowing them to buy more U.S. goods than they can when they exchange their currency with a nation that has a stronger currency.  So a nation with a strong export economy would like to weaken their currency to entice the buyers of exports to their export market.  Giving them a trade advantage over countries that have stronger currencies.

The gold standard prevented nations from devaluing their currency and kept trade fair.  In the 20th century the U.S. was the world’s reserve currency.  And it was pegged to gold.  Making the U.S. dollar as good as gold.  But due to excessive government spending through the Sixties and into the Seventies the American central bank, the Federal Reserve, began to print money to pay for their ever growing spending obligations.  Thus devaluing their currency.  Giving them a trade advantage.  But because of that convertibility of dollars into gold nations began to do just that.  Exchange their U.S. dollars for gold.  Because the dollar was no longer as good as gold.  So nations opted to hold gold instead.  Instead of the U.S. dollar as their reserve currency.  Causing a great outflow of gold from the U.S. central bank.

Going off of the Gold Standard made the Seventies the Golden Age of Keynesian Economics

This gave President Richard Nixon quite the contrary.  For no nation wants to lose all of their gold reserves.  So what to do?  Make the dollar stronger?  By not only stopping the printing of new money but pulling existing money out of circulation.  Raising interest rates.  And forcing the government to make REAL spending cuts.  Not cuts in future increases in spending.  But REAL cuts in current spending.  Something anathema to Big Government.  So President Nixon chose another option.  He slammed the gold window shut.  Decoupling the dollar from gold.  No longer exchanging gold for dollars.  Known forever after as the Nixon Shock.  Making a Keynesian dream come true.  Finally giving the central bank the ability to print money at will.

The Keynesians said they could make recessions a thing of the past with their ability to control the size of the money supply.  Because everything comes down to consumer spending.  When the consumers spend the economy does well.  When they don’t spend the economy goes into recession.  So when the consumers don’t spend the government will print money (and borrow money) to spend to replace that lost consumer spending.  And increase the amount of money in circulation to make more available to borrow.  Which will lower interest rates.  Encouraging people to borrow money to buy big ticket items.  Like cars.  And houses.  Thus stimulating the economy out of recession.

The Seventies was the golden age of Keynesian economics.  Freed from the responsible restraints of the gold standard the Keynesians could prove all their theories by creating robust economic activity with their control over the money supply.  But it didn’t work.  Their expansionary policies unleashed near hyperinflation.  Destroying consumers’ purchasing power.  As the greatly devalued dollar raised prices everywhere.  As it took more of them to buy the things they once did before that massive inflation.

The only People Borrowing that QE Money are Very Rich People making Wall Street Investments

The Seventies proved that Keynesian stimulus did not work.  But central bankers throughout the world still embrace it.  For it allows them to spend money they don’t have.  And governments, especially governments with large welfare states, love to spend money.  So they keep playing their monetary policy games.  And when recessions come they expand the money supply.  Making it easy to borrow.  Thus lowering interest rates.  To stimulate those big ticket purchases.  But following the subprime
mortgage crisis those near-zero interest rates did not spur the economic activity the Keynesians thought it would.  People weren’t borrowing that money to buy new houses.  Because of the collapse of the housing market leaving more houses on the market than people wanted to buy.  So there was no need to build new houses.  And, therefore, no need to borrow money.

So this is the problem Ben Bernanke faced.  His expansionary monetary policy (increasing the money supply to lower interest rates) was not stimulating any economic activity.  And with interest rates virtually at 0% there was little liquidity Bernanke could add to the economy.  Resulting in a Keynesian liquidity trap.  Interest rates so close to zero that they could not lower them any more to create economic activity.  So they had to find another way.  Some other way to stimulate economic activity.  And that something else was quantitative easing.  The buying of financial assets in the market place by the Federal Reserve.  Pumping enormous amounts of money into the economy.  In the hopes someone would use that money to buy something.  To create that ever elusive economic activity that their previous monetary efforts failed to produce.

But just like their previous monetary efforts failed so has QE failed.  For the only people borrowing that money were very rich people making Wall Street investments.  Making rich people richer.  While doing nothing (so far) for the working class.  Which is why when Bernanke recently said they may start throttling back on that easy money (i.e., tapering) the stock market fell.  As rich people anticipated a coming rise in interest rates.  A rise in business costs.  A fall in business profits.  And a fall in stock prices.  So they were getting out with their profits while the getting was good.  But it gets worse.

The economy is not improving because of a host of other bad policy decisions.  Higher taxes, more regulations on business, Obamacare, etc.  And a massive devaluation of the dollar (by ‘printing’ all of that new money) just hasn’t overcome the current anti-business climate.  But the potential inflation it may unleash worries some.  A lot.  For having a far greater amount of dollars chasing the same amount of goods can unleash the kind of inflation that we had in the Seventies.  Or worse.  And the way they got rid of the Seventies’ near hyperinflation was with a long, painful recession in the Eighties.  This time, though, things can be worse.  For we still haven’t really pulled out of the Great Recession.  So we’ll be pretty much going from one recession into an even worse recession.  Giving the expression ‘the worst recession since the Great Depression’ new meaning.

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Ben Bernanke defends QE3 before Congress even while Admitting it won’t Create any New Jobs

Posted by PITHOCRATES - October 6th, 2012

Week in Review

Ben Bernanke, Federal Reserve Chairman, is a student of the Great Depression.  And of Milton Friedman.  Who he cited often to support his policies when speaking before Congress.  Insisting that their expansionary monetary policy will only stimulate growth.  Not inflation.  Of course, he has already tried quantitative easing one and two and they failed.  As demonstrated by the need of QE3.  Yet these Keynesians always go back to the tried and failed Keynesian policies.  Increase the money supply to lower interest rates.  To encourage people to build and sell new housing while the market is still flooded with homes left over when the housing bubble burst back in 2008.

Economics is not like trying to cure a hangover.  A little hair of the dog (drinking more alcohol to mitigate the effects of a hangover) doesn’t work in economics.  More bad monetary policy does not cure previous bad monetary policy.  At least, it hasn’t yet.  Nor does it appear that it ever will (see Bernanke presses Congress to support US economy by AFP posted 10/2/2012 on Channel News Asia).

Federal Reserve Chairman Ben Bernanke said on Monday he is confident the US economy will continue to expand, but he urged the US Congress and the White House to act to support stronger growth…

However, he said the economy is growing at a weak 1.5-2 percent rate, not fast enough to lower the employment rate, and that the Fed’s stimulus efforts need to be backed up by action from the rest of the government…

“Many other steps could be taken to strengthen our economy over time, such as putting the federal budget on a sustainable path, reforming the tax code, improving our educational system, supporting technological innovation, and expanding international trade,” Bernanke said.

“In particular, the Congress and the administration will soon have to address the so-called fiscal cliff, a combination of sharply higher taxes and reduced spending that is set to happen at the beginning of the year.

“According to the Congressional Budget Office and virtually all other experts, if that were allowed to occur, it would likely throw the economy back into recession,” he warned.

Bernanke is on to something here.  He acknowledges that the new taxes of the fiscal cliff could throw the economy back into recession.  So if more taxes will prolong or deepen the recession what can we infer from this?  Would not fewer taxes have the opposite effect?

This is the frustrating thing about all of these students of the Great Depression.  They only look at what the Fed did when they were contracting the money supply.  And nothing else.  They don’t talk about a massive increase in tariffs (the Smoot-Hawley Tariff Act of 1930) in Congressional committee during 1929.  Before the Stock Market Crash of 1929.  Nor do they discuss the progressive policies of Republican Herbert Hoover.  And his interference into market forces.  Trying to raise prices everywhere to help farmers earn more and allow employers to pay their employees more.  And the near doubling of federal income tax rates.  Talk about your economic cold shower.

This was a 180-degree turn from the pro-business polices of the Warren Harding and Calvin Coolidge administrations.  That let the Twenties roar with solid economic growth.  Yes, there were some inflationary monetary policies.  The Fed was no angel.  But the growth was strong even after the effects of inflation were factored in.  It was all those tax and tariff increases that turned a recession into a depression.  And then the bad Fed policy destroyed the banking industry on top of it.  Unfortunately, that’s the only part that any Keynesian ever sees.  What the Fed did.  Not the solid economic growth generated by low tax rates and a business-friendly environment.

The Fed’s artificially low interest rates pushed house prices into the stratosphere.  And because they were so high in 2008 they had a very long way to fall.  Which is why the Great Recession has been so painful and so prolonged.  Now they’re trying to stimulate the housing market again.  The very thing that got us into this mess in the first place.  Here’s another lesson the Keynesians need to learn.  Their expansionary policies make recessions longer and more painful.  And there is more to the economy than low interest rates.  For no matter how low they are if the environment is too business-unfriendly they won’t stimulate economic activity.  Lower tax rates and deregulation will.  But not lower interest rates.  That’s what Warren Harding/Calvin Coolidge did.  What JFK did.  What Ronald Reagan did.  What George W. Bush did.  Who all had much faster recoveries following bad recessions than President Obama is having under his Keynesian policies.

If only we could learn the objective lessons of history.  For as George Santayana (1905) said, “Those who cannot remember the past are condemned to fulfill it.”

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After the Fed says they will Print More Money (QE3) Egan-Jones downgrades U.S. Sovereign Debt

Posted by PITHOCRATES - September 16th, 2012

Week in Review

Back when the Congress and the White House were battling it out to raise the debt limit the final compromise to raise the limit caused Standard and Poor’s to lower the U.S. sovereign debt rating for the first time in history.  The Left blamed the Republicans for refusing to raise taxes.  As if the excessive spending had nothing to do with it.  Well, another credit agency is downgrading the U.S. sovereign debt rating.  And this happened after the Fed announced QE3.  And nothing else (see Egan-Jones downgrades U.S. rating on QE3 move by Wallace Witkowski posted 9/14/2012 on Market Watch).

Egan-Jones Ratings Co. said Friday it downgraded its U.S. sovereign rating to AA- from AA on concerns that the Fed’s new round of quantitative easing, or QE3, will hurt the U.S. economy. The ratings agency said the Fed’s plan of buying $40 billion in mortgage-backed securities a month and keeping interest rates near zero does little to raise GDP, reduces the value of the dollar, and raises the price of commodities.

QE3 is Keynesian stimulus.  Printing money.  Which according to Egan-Jones won’t help the economy.  Apparently the people at Egan-Jones aren’t Keynesians.  Like in the Obama administration.  And at the Fed.  QE3 will devalue the dollar and raise prices.  While it may cause some short-term stimulus it will only make things worse in the long run.  Because of that inflation.  And it doesn’t address the real drag on the economy.  The anti-business policies of the Obama administration.  The biggest one being Obamacare.  With Taxmageddon right up there with it.  It’s the high taxes and costly regulatory policies that are holding back economic growth.  And devaluing the dollar doesn’t help these problems.  It only compounds them.  By raising prices.

QE3 will take a bad economy and make it worse.  Making the recession longer.  And the eventual recovery more painful.  Just like every recovery after a long period of inflation.  Just like after the Seventies.  Just like after the Nineties after the dot-com bubble burst.  Just like now after the subprime mortgage crisis.  There is a pattern here.  Easy money leads to irrational exuberance.  (Reckless spending encouraged by cheap money.)  And very unpleasant recoveries.  We got out of the early Eighties recession by cutting taxes.  Not with inflationary monetary policies.  We got out of the early 2000s recession by cutting taxes.  Along with some inflationary monetary policy.  The recovery wasn’t as long lasting as it was following the Eighties.  Now they are only proposing inflationary monetary policy without any tax cuts.  Which is why the Great Recession lingers still.  Proving tax cuts stimulate.  Not inflationary monetary policy.

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The Fed believes the Third Time’s the Charm when it comes to Printing Money so here comes QE3

Posted by PITHOCRATES - September 16th, 2012

Week in Review

The Keynesians will print more money.  QE3 is on its way.  The third round of quantitative easing.  Because QE3 will pull this economy out of recession.  Just as they said QE2 would.  Just as they said QE1 would before that.  And just because they failed the last two times they tried this doesn’t mean it will fail this time, too (see Fed Pulls Trigger, to Buy Mortgages in Effort to Lower Rates by Jeff Cox, CNBC, posted 9/13/2012 on Yahoo! Finance).

The Fed said it will buy $40 billion of mortgage-backed securities per month in an attempt to foster a nascent recovery in the real estate market. The purchases will be open-ended, meaning that they will continue until the Fed is satisfied that economic conditions, primarily in unemployment, improve…

Enacting the third leg of quantitative easing will take the Fed’s money creation past the $3 trillion level since it began the process in 2008.

According to the Wall Street Journal the Fed balance sheet stood at just below $1 trillion prior to the Great Recession.  That is, pre QE1.  Since then the Fed has increased that to $2.8 trillion prior to QE3.  An increase of 180%.  QE3 will take that above $3 trillion.  And increase from the level before the Great Recession of over 200%.    Meaning the monetary base after QE3 will be more than three times the monetary base prior to QE1.  And all during the Obama presidency.  In less than four years.  And just like QE1 and QE2 this latest quantitative easing won’t work either.  For like so many are saying if quantitative easing worked there would not have been a need for QE2 let alone QE3.  So it won’t help the economy.  But it will have an effect.

In addition, he addressed concerns that savers are being penalized from low interest rates, saying that the policy has allowed for growth in other areas.

“While low interest rates impose some costs, Americans will ultimately benefit most from the healthy and growing economy that low interest rates promote,” he said.

Small business owners have no idea of the full impact of Obamacare on their businesses.  So they are not hiring anyone anytime soon.  And then there’s Taxmageddon.  The largest tax increase in history to occur 1/1/2013.  Environmental policy.  And so on.  These are the things preventing people from hiring new employees.  And no amount of cheap money will change that.  Some people understand this.  Keynesians don’t.  In fact, the only thing they understand is spending money.  The key to economic activity is putting as much money into the hands of spenders as possible.  So they spend it.  And the people that get this money spend it, too.  And the people that get this money spend it after they get it.  And so on.  According to the Keynesian multiplier.  Where spending begets more spending.  Spending is good.  But savings is not.  According to Keynesians.  They see saving as lost economic activity.  Leakage from the economy.  So they want people to save as little as possible.  So they like low interest rates.  Because it provides no incentive for people to save.  So Keynesian policies penalize savers.  They understand this.  And they approve of this.

Of course with all the money the Fed is printing there will be inflation.  It’s just a matter of time.  We’d have double digit inflation right now based on the growth of the monetary base if there weren’t worse economies than the U.S. economy.  Some Eurozone countries are so bad no one wants to invest in their economies.  So they’re parking their money in the U.S.  Even at these low interest rates.  Even paying banks (i.e., negative interest rates) to hold their money.  Because it is the safest alternative.  But how long can this last?

The stock market, which had been slightly positive prior to the decision, shortly after 12:30 p.m., surged while bond yields, particularly farther out on the curve, jumped higher. Gold and other metals gained at least 1 percent across the board while the dollar slid against most global currencies…

Washington conservatives have been critical of the central bank’s money creation, which has caused its balance sheet to swell to $2.8 trillion. They worry that the growing money supply will lead to inflation, which has reared its head in food and energy prices but has remained tame through the broader economy.

Bill Gross, who runs bond giant Pimco, said the new round of easing would take the Fed’s balance sheet up to nearly $3.5 trillion if the purchases continue for a year.

“That potentially is reflationary,” he told CNBC. “We’re just to have to see if it works.”

Bonds issued when interest rates were higher have increased in value.  Because you can’t buy bonds today at such a high interest rate.  So older bonds (with higher interest rates) are worth more than newer bonds (at lower interest rates).

Gold increases in value when the value of the dollar drops.  Because the price of gold is in dollars.  So when you put more dollars into the monetary base you depreciate the dollar.  And raise prices.  Because it takes more weaker-dollars to buy the same things the once stronger-dollars bought.

So far inflation has been confined to food and energy.  Where it is harder to hide.  Especially oil.  Because it’s sold by the barrel for dollars.  So when you make the dollar weaker you send up the price of oil.  And everything you make from oil.  Like gasoline.  Which is why gasoline prices are approaching record highs.  Not because of a booming economy.  But because of inflation.

There is inflation in food, too.  But you can hide this a little.  You can keep prices steady while reducing portion sizes.  So the price per unit portion sold is higher.  But people don’t notice this as much as they do the price at the pump.  Where they cannot reduce the portion size.  Because gas is sold by the gallon.  Which means the full effect of Keynesian inflation monetary policy is reflected in the gas price.  Which is why high gas prices anger us more than just about everything else.

So inflation is here.  And at the rate they’re printing money it’s going to explode sooner or later.  For they’re printing it at a far greater rate than they did during the stagflation of the Seventies.  Giving Jimmy Carter that high misery index (unemployment rate plus the inflation rate).  A policy that did not help Carter’s economy.  Nor will it help the current economy.  In fact, it will only take a bad economy and make it worse.

If printing money worked the Seventies would have been a decade of unprecedented growth.  But they weren’t.  In fact all nations that printed money suffered from high inflation.  And poor economic growth.  Yet they pursue the same policy today.  Why?  Because if they don’t it’s an admission that their policies have been failures.  At the same time admitting that the Republican policies are better policies.  And they would rather throw the country into another depression before admitting that.

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