QE Pains and Gains

Reprinted from Bloomberg.

The Unintended Consequences of Quantitative Easing

Asset inflation doesn’t have to be bad. Flush governments could invest in education and infrastructure.
August 21, 2017, 11:00 PM PDT

Quantitative easing, which saw major central banks buying government bonds outright and quadrupling their balance sheets since 2008 to $15 trillion, has boosted asset prices across the board. That was the aim: to counter a severe economic downturn and to save a financial system close to the brink. Little thought, however, was put into the longer-term consequences of these actions.

From 2008 to 2015, the nominal value of the global stock of investable assets has increased by about 40 percent, to over $500 trillion from over $350 trillion. Yet the real assets behind these numbers changed little, reflecting, in effect, the asset-inflationary nature of quantitative easing. The effects of asset inflation are as profound as those of the better-known consumer inflation.

Consumer price inflation erodes savings and the value of fixed earnings as prices rise. Aside from the pain consumers feel, the economy’s pricing signals get mixed up. Companies may unknowingly sell at a loss, while workers repeatedly have to ask for wage increases just to keep up with prices. The true losers though are people with savings, which see their value in real purchasing power severely diminished.

John Maynard Keynes famously said that inflation is a way for governments to “confiscate, secretly and unobserved, an important part of the wealth of their citizens.” Critically, inflation creates much social tension: “While the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at the confidence in the equity of the existing distribution of wealth.”

Asset inflation, it turns out, is remarkably similar. First, it impedes creative destruction by setting a negative long-term real interest rate. This allows companies that no longer generate enough income to pay a positive return on capital to continue as usual rather than being restructured. Thus the much-noted growth of zombie companies is one consequence of asset price inflation. Thus also the unreasonable leverage and price observed in real estate, with the credit risks it entails for the future.

Second, it also generates artificial winners and losers. The losers are most found among the aging middle class, who, in order to maintain future consumption levels, will now have to increase their savings. Indeed, the savings made by working people on stagnant wages effectively generates less future income because investable assets are now more expensive. The older the demographics, the more pronounced this effect. Germany, for instance, had a contraction of nearly 4 percent of gross domestic product in consumer spending from 2009 to 2016.

The winners are the wealthy, people with savings at the beginning of the process, who saw the nominal value of their assets skyrocket. But, as with consumer inflation, the biggest winner is the state, which now owns through its monetary authority, a large part of its own debt, effectively paying interest to itself, and a much lower one at that. For when all is accounted for, asset inflation is a monetary tax.

The most striking similarity between consumer price inflation and asset inflation is its potential to cause social disruption. In the 1970s workers resorted to industrial action to bargain for wage increases in line with price increases.

Today, the weakened middle class, whose wages have declined for decades, is increasingly angry at society’s wealthiest members. It perceives much of their recent wealth to be ill-gotten, not resulting from true economic wealth creation [and they are correct], and seeks social justice through populist movements outside of the traditional left-right debate. The QE monetary disruption almost certainly contributed to the protest votes that have been observed in the Western world.

The central banks now bear a large responsibility. If they ignore the political impact of the measures they took, they will exacerbate a politically volatile situation. If, on the other hand, the gains made by the state from QE can be channeled to true economic wealth creation and redistribution, they will have saved the day.

This is entirely possible. Rather than debating how and how fast to end quantitative easing, the central bank assets generated by this program should be put into a huge fund for education and infrastructure. The interest earned on these assets could finance real public investment, like research, education and retraining. [That’s fine, but it does little to compensate for the massive transfer of existing wealth that is causing the political and social dislocations, such as unsustainable urban housing costs.]

If the proceeds of QE are invested in growth-expanding policies, the gain will help finance tomorrow’s retirements, and the government-induced asset inflation can be an investment, not simply a tax.

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Interesting Money Graphics

08-roman-empire-chart

dollar_devaluation

One cannot take these graphs at face value, for example, the long $ decline from 1933 to the present has also been the Pax Americana where the US has dominated geopolitics. Also, the Roman denarius was a commodity based currency, while the US$ is a fiat currency backed by US government taxing power over US assets.

But the larger issue of the costs of empire over time are instructive. One should dig deeper in analysis, but not be too complacent. Especially in light of the currency manipulations of the current age.

At Long Last, the Fed Faces Reality

The Fed faces reality? After 8 years, I’m not holding my breath…

Unconventional monetary policy—including years of ultralow interest rates—simply hasn’t delivered.

By GERALD P. O’DRISCOLL JR.

WSJ, Dec. 15, 2016 

As was widely anticipated, Federal Reserve officials voted Wednesday to raise short-term interest rates by a quarter percentage point—only the second increase since the 2008 financial crash. The central bank appears to have finally confronted reality: that its unconventional monetary policy, particularly ultralow rates, simply has not delivered the goods.

In a speech last week, the president of the New York Fed, William Dudley, brought up “the limitations of monetary policy.” He suggested a greater reliance on “automatic fiscal stabilizers” that would “take some pressure off of the Federal Reserve.” His proposals—such as extending unemployment benefits and cutting the payroll tax—were conventionally Keynesian.

Speaking two weeks earlier at the Council on Foreign Relations, Fed Vice Chairman Stanley Fischer touted the power of fiscal policy to enhance productivity and speed economic growth. He called for “improved public infrastructure, better education, more encouragement for private investment, and more effective regulation.” The speech, delivered shortly after the election, almost channeled Donald Trump.

Indeed, the markets seem to be expecting a bigger, bolder version of Mr. Fischer’s suggestions from the Trump administration.

• Infrastructure: Mr. Trump campaigned on $1 trillion in new infrastructure, though the details are not fully worked out. The left thinks green-energy projects—such as windmill farms—qualify as infrastructure. Living in the West, I’d prefer to build the proposed Interstate 11, a direct line from Phoenix, to Las Vegas and then to Reno and beyond.

• Education: Nominating Betsy DeVos to lead the Education Department shows Mr. Trump’s commitment to real education reform, including expanded school choice. Much of America’s economic malaise, including income inequality and slow growth, can be laid at the feet of deficient schools. Although some students receive a world-class education, many get mediocrity or worse.

• Private investment and deregulation: Mr. Trump promises progress on both fronts. He is filling his cabinet with people—including Andy Puzder for labor secretary and Scott Pruitt to lead the Environmental Protection Agency—who understand the burden that Washington places on job creators.

Businesses need greater regulatory certainty, and reasonable statutory time limits should be placed on environmental reviews and permit applications. That, along with tax cuts, would do the trick for boosting investment.

All that said, central bankers have a role to play as well. The Fed’s ultralow interest rates were intended to be stimulative, but they also squeezed lending margins, which further dampened banks’ willingness to loan money.

There’s a strong case for a return to normal monetary policy. The prospects for economic growth are brighter than they have been in some time, and that is good. The inflation rate may tick upward, which is not good. Both factors argue for lifting short-term interest rates to at least equal the expected rate of inflation. Depending on one’s inflation forecast, that suggests moving toward a fed-funds rate in the range of 2% to 3%.

The Fed need not act abruptly, but it also does not want to get further behind the curve. Next year there will be eight meetings of the Federal Open Market Committee. A quarter-point increase at every other meeting, at least, would be in order.

This could produce some blowback from Congress and the White House. Paying higher interest on bank reserves will reduce the surplus that the Fed returns to the Treasury—thus increasing the deficit. But the Fed could ease the political pressure if it stopped resisting Republican lawmakers’ effort to introduce a monetary rule, which would curb the central bank’s discretion and make its policy more predictable. This isn’t an attack on the central bank’s independence, as Fed Chair Janet Yellen has wildly argued, but an exercise of Congress’s powers under the Constitution.

The one big cloud that darkens this optimistic forecast is Mr. Trump’s antitrade stance. Sparking a trade war could undo all the potential benefits that his policies bring. David Malpass, a Trump adviser and regular contributor to these pages, argues that trade deals like the North American Free Trade Agreement are rife with special benefits for big companies, but that they do not work for America’s small businesses. The argument is that Mr. Trump wants to renegotiate these deals to make them work better. I hope Mr. Malpass is correct, and that President-elect Trump can pull it off.

But for now, a strengthening economy offers a chance to return to normal monetary policy. Fed officials seem to have come around to that view. With any luck, Wednesday’s rate increase will be only the first step in that direction.

Why…

…Aren’t Presidential Candidates Talking About the Federal Reserve?

Yes, why? Much of our economic and financial lives are being guided by an unelected board of Federal Reserve governors who have been flying blind for about 8 years now…manipulating interest rates and asset markets to what end? Nobody seems to know, except to try to prevent a financial reckoning for previous misguided policies. A less charitable interpretation is the financial industry’s desire to keep the casino open as the only game in town.

By Jordan Haedtler

In an election fueled by populist anger and dominated by talk of economic insecurity, why aren’t any of the presidential candidates talking about the Federal Reserve?

After nearly a decade of high unemployment, severe racial and gender disparities and wage stagnation, voters are heading to the ballot box in pursuit of a fairer economy with less rampant inequality. In California and New York, low-wage workers are celebrating historic agreements to raise the minimum wage to $15 per hour. And the economy and jobs consistently rank among the top concerns expressed by voters of all political stripes.

One government institution reigns supreme in its ability to influence wages, jobs and overall economic growth, yet leading candidates for president have barely discussed it at all. The Federal Reserve is the most important economic policymaking institution in the country, and it is critical that voters hear how candidates plan to reform and interact with the Fed.

Related: The Federal Reserve Bank, Explained [Well, kind of.]

The Fed too often epitomizes the problems with our economy and democracy over which voters are voicing frustration: Commercial banks literally own much of the Fed and are using it to enrich themselves at the expense of the American working and middle class. When Wall Street recklessness crashed the economy in 2008, American families paid the price.

At the time, JP Morgan Chase CEO Jamie Dimon sat on the board of the New York Federal Reserve Bank, which stepped in during the crisis to save Dimon’s firm and so many other banks on the verge of collapse. Although the Fed’s actions helped Wall Street recover, that recovery never translated to Main Street, where jobs and wage growth stagnated.

Commercial banks should not govern the very institution that oversees them. It’s a scandal that continues to threaten the Fed’s credibility. An analysis conducted earlier this year by my parent organization, The Center for Popular Democracy, showed that employees of financial firms continue to hold key posts at regional Federal Reserve banks and that leadership throughout the Federal Reserve System remains overwhelmingly white and male and draws disproportionately from the corporate and financial world.

Yellen-and-Rate-Hike-cartoon

When the Fed voted in December to raise interest rates for the first time in nearly a decade, the decision was largely driven by regional Bank presidents — the very policymakers who are chosen by corporate and financial interests. In 2015, the Fed filled three vacant regional president position, and all three were filled with individuals with strong ties to Goldman Sachs; next year, 4 of the 5 regional presidents voting on monetary policy will be former Goldman Sachs insiders. Can we trust these blue-chip bankers to address working Americans’ concerns?

Yet despite the enormous power it wields and the glaring problems it continues to exemplify, the Fed has received little attention this election cycle. As noted by Reuters last week, two of the remaining candidates for president, Hillary Clinton and John Kasich, have been mute on what they would do about the central bank. Donald Trump’s sporadic statements about the Fed have been characteristically short on details, prompting former Minneapolis Federal Reserve Bank President Narayana Kocherlakota to call for Clinton, Trump and all presidential candidates to clarify exactly how they plan to oversee the Fed’s management of the economy. Ted Cruz has piped up about the Fed on a few occasions, although his vocal endorsement of “sound money” and other policies that contributed to the Great Depression warrant clarification. [One expects that none of the candidates really understand the arcana of central banking and prefer to leave well enough alone.]

The most detailed Fed reform proposal from a presidential candidate to date was a December New York Times op-ed in which Bernie Sanders wrote that “an institution that was created to serve all Americans has been hijacked by the very bankers it regulates,” and urged vital reforms to the Fed’s governance structure.

On Monday, Dartmouth economist Andy Levin, a 20-year Fed staffer and former senior adviser to Fed Chair Janet Yellen and her predecessor Ben Bernanke, unveiled a bold proposal to reform the Federal Reserve and make it a truly transparent, publicly accountable institution that responds to the needs of working families. [That’s pretty vague, as the interests of all are best served by a monetary policy that insures the stability of the price level and value of the currency as a unit of exchange and store of value. Employment growth is best addressed through fiscal policy.]

The New York primary provides a perfect opportunity for the remaining presidential candidates to tell us what they think about the Federal Reserve. Candidates in both parties should specify whether they support Levin’s proposals, and if not, articulate their preferred approach for our federal government’s most opaque but essential institution.

As Trump, Cruz and Kasich gear up for a potentially decisive primary, they would do well to respond to the many calls for clarity on the Fed. And on Thursday night, Sanders and Clinton will have the chance to clarify their stances on the Fed when they debate in Brooklyn, just a few miles away from Wall Street and the global financial epicenter that is the New York Federal Reserve Bank.

As New York voters get ready to decide which of the remaining candidates would make the best president, they will be asking themselves which candidate will better handle the economy. The candidates’ positions on the Fed must be part of the equation.

Over Fed

America’s Bank – A Review

Interesting book review with highlights of the history of the Federal Reserve. We should keep in mind that all financial crashes are rooted in excess credit creation. Unconstrained credit creation has now become the primary strategy of our central banks.

An All Too Visible Hand

When Wilson signed the Federal Reserve Act into law in 1913, the very idea of a macroeconomy—something to be measured and managed—was yet to be invented

By James Grant

The Federal Reserve is America’s problem and the world’s obsession. When will Janet Yellen choose to lift the federal-funds rate from its longtime resting place of zero, thereby upending or not upending (it depends on whom you ask) individuals and markets in all four corners of the earth? Her subjects await a sign. While tapping their feet, they may ponder how things ever came to this pass. How, indeed, did such all-powerful body come into existence in the first place—and why?

Roger Lowenstein’s “America’s Bank,” which chronicles the passage of the 1913 Federal Reserve Act, is victor’s history. Its worldview is that of today’s central bankers, the bailers-out of markets, suppressors of interest rates and practitioners of money conjuring. In Mr. Lowenstein’s telling, what preceded the coming of the Federal Reserve was a financial and monetary dark age. What followed was the truth and the light.

It sticks in the craw of good Democrats that, in 1832, their own Andrew Jackson vetoed the rechartering of the Second Bank of the United States, the predecessor of the Federal Reserve. Just as galling is the fact that Old Hickory’s veto message is today counted as one of America’s great state papers. In it, Jackson denies to Congress the power to delegate its constitutionally given duty to “coin money and regulate the value thereof.” To do so, Jackson affirmed, would render the Constitution a “dead letter.”

America’s Bank

By Roger Lowenstein

Mr. Lowenstein contends that, in the creation of the Federal Reserve 80 years later, Congress and the people commendably put that hard-money Jacksonian claptrap behind them. Mandarin rule is the way forward in monetary policy, he suggests—the Ph.D. standard, as one might call it, under which former tenured economics faculty exercise vast discretionary power over the value of money and the course of interest rates, financial markets and business activity. Give Mr. Lowenstein this much: As the world awaits the raising of the Fed’s minuscule interest rate, the questions he provokes have never been timelier. Not for the first time the thoughtful citizen must wonder: What’s money and who says so?

When Woodrow Wilson signed the Federal Reserve Act into law in 1913, the dollar was defined as a weight of gold. You could exchange the paper for the metal, and vice versa, at a fixed and statutory rate. The stockholders of nationally chartered banks were responsible for the solvency of the institutions in which they owned a fractional interest. The average level of prices could fall, as it had done in the final decades of the 19th century, or rise, as it had begun to do in the early 20th, without inciting countermeasures to arrest the change and return the price level to some supposed desirable average. The very idea of a macroeconomy—something to be measured and managed—was uninvented. Who or what was in charge of American finance? Principally, Adam Smith’s invisible hand.

How well could such a primitive system have possibly functioned? In “The New York Money Market and the Finance of Trade, 1900-1913,” a scholarly study published in 1969, the British economist C.A.E. Goodhart concluded thus: “On the basis of its record, the financial system as constituted in the years 1900-1913 must be considered to have been successful to an extent rarely equalled in the United States.”

The belle epoque was not to be confused with paradise, of course. The Panic of 1907 was a national embarrassment. There were too many small banks for which no real diversification, of either assets or liabilities, was possible. The Treasury Department was wont to throw its considerable resources into the money market to effect an artificial reduction in interest rates—in this manner substituting a very visible hand for the other kind.

Mr. Lowenstein has written long and well on contemporary financial topics in such books as “When Genius Failed” (2000) and “While America Aged” (2008). Here he seems to forget that the past is a foreign country. “Throughout the latter half of the nineteenth century and into the early twentieth,” he contends, “the United States—alone among the industrial powers—suffered a continual spate of financial panics, bank runs, money shortages and, indeed, full-blown depressions.”

If this were even half correct, American history would have taken a hard left turn. For instance, William Jennings Bryan, arch-inflationist of the Populist Era, would not have lost the presidency on three occasions. Had he beaten William McKinley in 1896, he would very likely have signed a silver-standard act into law, sparking inflation by cheapening the currency. As it was, President McKinley signed the Gold Standard Act of 1900, which wrote the gold dollar into the statute books.

The doctrine that interest rates are the Federal Reserve’s to manage has come to be regarded, at least by the mandarins, as settled science. It was not so when the heroes of Mr. Lowenstein’s story were conspiring to create a new central bank. Abram Piatt Andrew Jr. took to the scholarly journals to denounce the government’s attempts to pin down money-market interest rates.

Indiana-born, Andrew came East to study, taught economics at Harvard and lent his talents to the National Monetary Commission in 1909 and 1910—the group that conducted the field work to prepare for the grand banking reform. Somewhere along the line, he conceived the idea that the money market should be free of federal manipulation. As prices had been rising—a gentle inflation had begun just before the turn of the 20th century—interest rates should have followed prices higher. That they did not was the complaint that Andrew laid at the doorstep of the government.

Andrew contended that the Treasury Department—under Lyman J. Gage, who served from 1897 to 1902, and his successor, Leslie M. Shaw, who resigned in 1907—“succeeded in keeping the money rate of interest below the rate which would have been ‘normal’ or ‘natural.’ . . . They had kept alive a continuously excessive demand for credit by making it available at less than the normal cost. They had sown the wind and their successor was to reap the whirlwind.”

It is an indictment that comes ready-written against the Federal Reserve’s policy today. Interest rates are prices. Far better that they be discovered in the marketplace than administered from on high. One has to wonder what Andrew would say if he were spirited back to earth to read a random edition of this newspaper in the seventh year of the Fed’s attempt to create prosperity through the technique of zero-percent interest rates. He might want a quiet word with Ms. Yellen.

Andrew is not the only vivid personality in this tale of unintended consequences. Mr. Lowenstein entertainingly limns a gallery of them: Paul Warburg, a German-banker immigrant eager to import European ideas into his adopted country; Carter Glass, an irritable Virginia newspaperman turned congressman (later senator) and currency reformer; Nelson Aldrich, a suspiciously affluent Rhode Island senator and central-bank exponent; Robert Owen, a former Indian agent from the Oklahoma Territory who pushed the Federal Reserve Act through the Senate; William Gibbs McAdoo Jr., the Treasury secretary who married the boss’s daughter; that boss himself, Woodrow Wilson; and Frank Vanderlip, president of what today is Citigroup.

Vanderlip, not alone among his fellow agitators for a central bank, was keen on the gold standard and “fervent,” as Mr. Lowenstein puts it, in his “denunciations of government control.” Here is a fine piece of irony. Government control is exactly what the authors of the Federal Reserve Act unintentionally achieved, though Andrew, at least, might have anticipated this public-policy reversal. He noticed that, under Leslie Shaw’s meddling stewardship in the early years of the 20th century, the Treasury had shifted government deposits to private institutions in times of crisis. “Outside relief in business, like outdoor charity,” as Mr. Lowenstein quotes him saying, “is apt to diminish the incentives to providence, and to slacken the forces of self-help.”

Centralized government control arrived in force with the Banking Act of 1935. It established the centralization of monetary power within the Federal Reserve Board in Washington, and it repealed the so-called double-liability law on bank stocks: No more would the holders of common stocks in failed banks be assessed to help defray the debts of the institutions in which they had invested. Anyway, there would be precious few failures to deal with, proponents of the new thinking contended. Knowing that the Federal Deposit Insurance Corp. stood behind their money, depositors would give up running; they would rather walk to the bank.

The new doctrines repulsed H. Parker Willis, a key player during the organization of the Fed and later a professor of banking at Columbia University. “It is far better, both for the depositor and the banker,” said Willis of the FDIC, “that the actual net irreducible losses growing out of bank failure should fall where they belong. The universal experience with this kind of insurance—if it may be called—has pointed to the danger of increasing losses as the result of bad banking management induced by belief in deposit guarantee.”

Willis didn’t imagine the half of it. On top of deposit insurance evolved the notion that some banks—Citi, for instance—were too big to fail. They must be nurtured through subsidy and bank-friendly monetary policy: low money-market interest rates, for example. It happened that the Citigroup that evolved from Vanderlip’s National City Bank became a ward of the state in 2008. The massive federal bailout of Citi exacted many costs, including a level of regulatory micromanagement that Vanderlip could not have begun to conceive.

J.P. Morgan Chase, which did not fail in 2008, recently went public to describe the intensity of the federal oversight it labors under. More than 950 employees, it revealed, are dedicated to complying with 750 requirements laid down by 21 government entities to achieve and maintain capital adequacy. The Fed itself is high among those demanding overseers. The workers shuffle 20,000 pages of documentation and manipulate 225 econometric models.

The rage to micromanage spans the world. “It can’t be,” the head of Sweden’s Nordea Bank was quoted forlornly saying last year in the Financial Times, “that the only purpose of banking is to stop banks from going bankrupt.” Oh, yes it can.

One thinks back to the supposed financial dark ages when, in 1842, New Orleans bankers, setting down a kind of operational manifesto, succeeded in committing the essentials of safe and sound banking practice to one side of one page. They prospered by simple maxims—e.g., do what you will with your own capital but do not abuse the depositor’s funds—well after the Civil War. Some may protest that banking has become more complex since those days. The boggling, 23,000-page length of the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010 (complete with supporting rules) would suggest that it has become 23,000 times more complex. I doubt that.

The legislation to which President Wilson affixed his signature in 1913—Mr. Lowenstein observantly notes that he signed with gold pens—included no intimation of the revolutionary techniques of monetary control that would come into being after 2008: zero-percent interest rates, “quantitative easing,” and central-bank-sponsored bull markets in stocks and real estate, among others.

The great value of “America’s Bank” is the comparison it invites between what lawmakers intend and what they achieve. The act’s preamble described a modest effort “to provide for the establishment of the Federal Reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper and to establish a more effective supervision of banking in the United States and for other purposes.” “And for other purposes”—our ancestors should have known.