Streetwise Professor

November 8, 2010

QE2 or Titanic?

Filed under: Uncategorized — The Professor @ 11:15 am

The Federal Reserve has launched a second round of “quantitative easing”–QE2.   How is it that this “easing” leaves me uneasy?

Macro is not my thing.  But economics is economics, and I know enough to have serious questions about quantitative easing.  I may not be able to tailor a magnificent macro suit, but I can pretty much tell when the king is naked, and I think that’s the case here.

Bernanke is arguing that easing is needed because of deflationary concerns.  But has there ever been a deflationary episode during which commodity prices spurted ahead?  Definitely not during the 1930s.  Not in the 1920-1921 crash (which at its outset was more severe than the Great Depression).  Not in 1893.  In all of these episodes, commodity prices crashed.  So if this is deflation, it is a weird deflation.

Bernanke was asked about this specifically at a presentation at Jacksonville University.  His answer was not comforting:

Asked by a student if “skyrocketing” commodities prices may threaten his inflation outlook, Bernanke said rising commodities prices are “the one exception” to a broad reduction in inflationary pressures. Overall, excess slack in the economy will make it difficult for producers to push through higher prices to consumers, he said.

Well, exceptions can be pretty damned informative.  Anomalies are the things that should make you question your analysis.  If there is “excess slack” why is the demand for commodities high?

Relatedly, in what deflationary or near deflationary episode has the country facing the more severe deflation problem seen its currency depreciate, rather than appreciate?  Japan’s skyrocketing yen is consistent with deflationary pressures there.  Commodity prices have risen little, if at all, in yen terms.  But the dollar has cratered.  How is that consistent with a US deflationary episode?  Another anomaly in the deflation story.

Bernanke is known primarily as an expert on the Great Depression.  It is pretty clear that that is the mental model he is relying on when deciding that QE is necessary.  But there is always the possibility that he is the general fighting the last war.  Or that he is the master with the hammer, but the current problem isn’t a nail.  Before plunging ahead with a radical scheme, I’d want to have a better understanding why these anomalies exist, and what they mean.  To me, they suggest that the Depression template is a very bad fit.  But it is driving his thinking.  I am worried when people fix monomaniacly on things that confirm their priors and dismiss those that don’t.  That’s not the recipe for wise decisions.

Bernanke acknowledged in a WaPo oped that the 2008 crash was a global phenomenon, but that the slow recovery is primarily an American (and Japanese) one.  In the Jacksonville talk, he acknowledged that emerging markets are booming.  Parts of Europe, especially Germany, are growing smartly.  Even the UK has bounced back better than the US.  So what makes the US different?  Is this difference something that can be addressed by QE?  

I have my doubts, particularly in an open economy: a lot of the stimulus will spill over to–is spilling over–to emerging markets.  I think that there is a good possibility that America’s economic sluggishness is a reflection of the grim fiscal situation and the spate of regulatory and other government burdens that have been piled on in the last 2 years.  If that’s the case, then QE2 will not correct stagnation, and risks stagflation.

I also have my doubts as to how this is going to work, exactly.  In his WaPo oped, Bernanke touts the interest rate channel.  That’s hardly persuasive.  He also mentions boosting the stock market, and I think that is more accurately reflective of his true strategy.  QE2 is a hair of the dog gambit: asset bubbles got us into this mess, an asset bubble will get us out.  He’s not Helicopter Ben–he’s Bubble Ben.

I could see–barely–this working if QE were to boost housing prices.  This would ease pressure on household balance sheets, drying out underwater mortgages, which could spark an increase in consumption.

But although Ben can open the monetary floodgates, he’s powerless to direct where the flood of money goes.  Right now it’s heading to emerging markets, commodities, and to some degree stocks.  Housing does not seem to be benefitting.  And this could be contbuting to the QE decision loop.  The Fed and Bernanke point to the CPI as evidence that there is little inflation, and that we are on the cusp of deflation.  But CPI has a large housing component (about 25 percent, if memory serves).  This could be giving a misleading picture of true inflationary pressures.

I wonder what the monetary channels are now.  One possibility is that easing leads to asset price inflation first and foremost, and that goods price inflation occurs with a lag.  By the time that monetary pressures show up in the goods price measures that the Fed/Bernanke are monitoring, it may be too late to intervene to prevent a big inflationary spurt, or any such intervention may crater the economy.  The dilemma that I disussed in late-08 to early-09–where the Fed is faced with the grim choice between rampant inflation and a major recession–is still present.

This means that QE is unlikely to do anything to boost the American economy.  At the same time it is already sharply increasing international tensions in a way that poses a real risk of trade, currency, and investment protectionism.

All of this also injects a tremendous amount of uncertainty into the economy.  This uncertainty makes decision making harder–and investment/resource allocation mistakes more likely.  I once quoted Sherwin Rosen’s bracing remark in his Econ 300 class in Chicago in ’82 or ’83: “The problem with inflation is that it f*cks up relative prices.”  Well, even if QE doesn’t spark measured inflation, it almost certainly will–and arguably already is–f*cking up relative prices.  That’s not good.  And just the uncertainty itself is a drag on the economy, as decision makers decide that procrastination is the better part of valor.

You don’t have to go all Austrian to have serious concerns that continued monetary stimuli can distort price signals, leading to perverse resource allocations, and economic problems down the road when these misallocations become manifest. 

In brief: I see a lot of icebergs out there, but Captain Ben has just ordered all ahead full.  I hope there are enough lifeboats.

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  1. I believe the perverse resource allocations in the current setting are the commodities and emerging markets bubble. Emerging markets bubble is most likely happening because of huge dollar influx as a result of low borrowing costs in the US (thanks to Ben) and much higher returns in EM. Wonder what type of restrictions are placed on the money remaining for investment in the US.

    Comment by Surya — November 8, 2010 @ 12:32 pm


    Arkady Dvorkovich saying: “Russia’s president will insist … that such actions are taken with preliminary consultations with other members of global economy.”

    In other words, keep printing that money and will make another heaping order of euros, dump some dollars, and buy gold Mr. Bernanke.

    Comment by The Other Ivan — November 8, 2010 @ 12:40 pm

  3. Bernanke’s behaviour is completely explained by 5 year inflation swaps. When they were above 2.4% back in January, he was loudly talking about the exit strategy. When they dropped to 1.5% in August, he started talking about QE2. If they rise to 2.4% again, it is very likely that QE2 will be paused.

    Comment by The Money Demand Blog — November 8, 2010 @ 6:22 pm

  4. What Bernanke really wants is certainty that inflation will rise by 2% p.a. – no more, no less.

    Comment by The Money Demand Blog — November 8, 2010 @ 6:24 pm

  5. In my view commodity prices are spurting ahead because most commodity markets have become financialised, and at the zero bound investors whose motive is Fear are ‘hedging inflation’ – unlike the dreaded speculators in search of a transaction profit whose motive is Greed – and in aiming to avoid loss, they therefore buy ANYTHING but dollars, income or no income.

    More QE can only make this problem worse, especially as ETFs get into physical commodities, which the good old FSA has spotted may be A Bad Thing.

    The bottom line is that the average American (and the average Brit, Paddy & Miguel) is bust. 90% of US citizens are in debt to the other 10% who own almost all US productive assets, particularly land.

    Unless and until systemic fiscal reform takes place aimed at addressing this imbalance, the financial system is basically screwed.

    Comment by Chris Cook — November 9, 2010 @ 1:12 pm

  6. Jan Hatzius of Goldman thinks otherwise! Perhaps this is yet another GS scheme 😀

    Comment by Surya — November 10, 2010 @ 10:51 am

  7. As I wrote above, for once the Kremlins and Professor Pirrong are in complete agreement. Putvedev don’t want their immense U.S. dollar holdings turned into toilet paper — even if it would let them piss off Pirrong by buying half the refineries and shale gas players in Houston plus the Hardisty-Cushing pipeline dirt cheap. 🙂

    I would go one further, and argue that Bernanke is an imperialist money printing stooge of the enemies of the Russian and American people, the one-worlders (like Soros) who wants to starve WWII veteran babushkas AND put more Americans on food stamps just to inject a little more juice into the zombie banks and the present unsustainable fiat money system. It’s like a heroin junkie selling their gold teeth and coat for one more score. These are the same a–holes who pour foreign aid into Georgia so that county can have a plug-in electric hybrid car AND rearmament program while the average Georgian wage is $300 a month (here’s looking at you Andrew, since I suspect you work for one of those Open Society backed intel/globalist fronts — excuse me, peaceful NGOs).

    And as a bonus, the one-worlders want do exactly to America what they did to Russia in the 90s — destroy the currency, prey on a clique of completely incompetent politicians and get the ‘reformers’ in their back pocket, and buy up the juiciest assets for dimes if not kopeks on the dollar/ruble (you notice all of the discussion at the state and federal level is about dumping the public employee unions, which needs to happen, and entitlement reforms, but nary a peep about cutting our bloated defense/intelligence budget or corporate welfare which would hurt the fatcats and the better living through looting crowd in D.C. I hope Ron and Rand get busy and start changing that, along with dropping the stupid embargo against Cuba which serves to artifically prop up health care and pharma costs and otherwise piss off the neocons who are hellbent on more shadow wars and not cutting the defense budget one iota even as parts of the U.S. sink into Thirld World status)

    This now concludes your Russophile Zero Hedge/Matt Taibbi wannabe rant.

    Comment by The Other Ivan — November 10, 2010 @ 2:05 pm

  8. Trying to understand QE2 repercussions better, I found the following paragraph in Roubini’s site interesting:

    QE2 and the currency war

    Meanwhile there has been a real flurry of attacks on QE2 in China. Tuesday’s People’s Daily has an article (“China vows to collar US over monetary policies”) that starts:

    China yesterday urged the United States to “act responsibly” in its monetary policies, and said that concerns will be raised at the upcoming G20 summit in Seoul, South Korea. Vice Minister of Finance Zhu Guangyao made the remarks at a press briefing on President Hu Jintao’s attendance to the meeting.

    The US Federal Reserve last week announced plans to purchase US$600 billion worth of government bonds in a bid to revive the sluggish economy. The near-zero US interest rate and a weak dollar are expected to push liquidity into Asian countries, potentially destabilizing emerging economies.

    Zhu urged the United States to “realize its responsibility and obligation as a major currency issuing country, and take responsible macroeconomic policies. “We will have candid discussions with the US side. We hope its macroeconomic policy can be conducive to the development of the world economy, not the contrary,” Zhu said.

    What an impasse. China and other countries are right to claim that QE2 is likely to lead to asset bubbles outside the US, but only, as the US points out, in countries that intervene to prevent dollar depreciation, something the US is anyway eager to discourage. If Beijing is correct however in claiming, as it has for many years, that Chinese currency policies should be aimed at China’s needs, not those of the US, it is hard for them to dispute the Fed’s argument that Fed monetary policies should be aimed at satisfying the needs of the US economy, not the needs of China.

    Comment by Surya — November 10, 2010 @ 4:08 pm

  9. Food, petroleum, and rent are my three biggest expenses. Since the QE I have seen food and gasoline prices rise. I feel like Bernanke just shredded my budget. As far as I am concerened he is my family’s enemy.

    Comment by Matt — November 13, 2010 @ 2:33 am

  10. @Matt–I sympathize. Not to be a total downer, but the scary thing is that Bernanke’s objective is to raise the price of the third item you listed–housing. Food & gas are just collateral damage to him.

    The ProfessorComment by The Professor — November 14, 2010 @ 9:02 am

  11. @OI–I will let pass in silence most of your comment. One remark is so amazing, however, that I have to say something: “the one-worlders want do exactly to America what they did to Russia in the 90s–destroy the currency etc.” Really. All that you describe was self-inflicted. The one-worlders had nothing to do with it. It had Made in Russia–or Made in the USSR–stamped all over it. The emission of rubles at a catastrophic rate began in the 1980s. The shortages of virtually every consumer item was a manifestation of suppressed inflation. As soon as price controls were removed, the suppressed inflation became actual inflation. Subsequently, the Russian central bank and the other FSU central banks continued to print money like crazy, with predictable consequences. It was due to the complete fiscal collapse of the state. Insofar as acquisition of assets for kopecs is concerned–again, an almost completely Russian phenomenon. The crooks were all Russian. Look at the roster of those who became rich by getting state assets for a song–not a one-worlder among them. Entirely Russian (or, at least people who had grown up in the USSR, with a few Ukrainians, Armenians, etc., making a killing).

    The ProfessorComment by The Professor — November 14, 2010 @ 9:09 am

  12. Professor,

    With all due respect, the Soviets may have been to blame for most of the post-Soviet turmoil by destroying the economic AND moral order of Russia, but you’d have to be an idiot to deny that Soros was in on the ground floor with at least a few of the oligarchs. Even rigged auctions still required someone to come up with several million into the tens of millions of bucks. And some of that cash had to have come from outside of Russia. The evidence is overwhelming — especially since Oleg Deripaska is one of your least favorite oligarchs, and you wonder how he acquired and hung on to so many alumina mills during the so-called ‘Metal Wars’ of the Nineties — how much more so did Soros manage to keep ownership of one of the largest steel complexes in Russia, which Soros sold to Forbes’ newest rich list topper?

    The fact is, if you’ve ever been to Bulgaria and seen the oldest NGOs, virtually all of them were started with Soros seed money in the late 80s…even before the collapse of Communism in those countries. What were those NGOs for? Sure, they helped some people, but they were basically eyes and ears for gathering economic intel and picking which targets for acquisition in a post-Soviet ‘New World Order’.

    These are the places that even Glenn Beck won’t go, preferring instead to discuss what Soros did as a teenager. The Weekly Standard, National Review, one and all can gripe about his philanthropy and support for Leftist causes, but they won’t touch his Eastern European manipulations and insider acquisitions with a ten foot pole. And that’s what bothers me, as if, like Russian media not discussing the earlier less savory aspects of the oligarchs careers, they know better than that.

    Comment by The Other Ivan — November 15, 2010 @ 5:13 pm

  13. @OI–I will never defend Soros. I don’t know with any specificity what he did, but know enough about him to suspect anything he is involved in. No doubt he exploited the lack of legal and moral order that was the legacy of the USSR in order to enrich himself at the expense of people throughout E. Europe and Russia.

    The ProfessorComment by The Professor — November 15, 2010 @ 7:50 pm

  14. […] we concentrate on QE2 (quantitative easing) opening with misgivings from Streetwise Professor. The Federal Reserve has launched a second round of “quantitative easing”–QE2.   How is it […]

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