Ignored by all but market-watchers and anti-Fed types, the Fed gave tacit encouragement to a QE3 strategy this week. Stimulus in the worst possible way. In fact, for all the attention that Obama’s jobs program and proposed tax hikes have been getting, right now it seems like a lot of sound and fury. Whatever compromise is going to come out of it, it is likely to be a lot of small ideas whose whole will be less than the sum of its parts. The Fed, on the other hand, under Bernanke’s ‘leadership’ has decided to buy up $400 billion in long-term bonds and sell an equivalent amount of short-term bonds. This move, coordinated with interventions by the European Central Bank, has been dubbed ‘Operation Twist’ after a previous operation from the 1960s (explainer here). (Is there no area of social life immune from military metaphors? Though perhaps it does say something about the anti-democratic ways and means of the Fed…)
The idea seems to be that, coupled with a zero percent interest policy, this will inject liquidity into a stagnant economy on the verge of a double-dip, and stimulate employment-generating investment rather than just allowing extra cash to sit in T-bills. And it’s a politically acceptable way of injecting liquidity because it does not increase the balance sheets of the Fed, just redistributes its holdings as a way of ‘twisting’ the yield curve on bonds.
We’ve been here before. Many of the arguments (here and here) against expansionary monetary policy still apply. But it’s even more problematic than we first thought. First, it’s worth noting that, as Perry Mehrling has been tirelessly demonstrating, this is all QE3 but under the table, as it were. Just to remind ourselves, QE1 was the buying up of lots of toxic assets to try to clean up bank balance sheets, avoid an even worse credit crunch, and had some real rationale insofar as it helped avoid a panic. (Hence ‘US 1’ in our title – we can accept this particular part as at least a necessity for the American economy). QE2 was the buying up of huge amounts of treasuries to drive down borrowing costs, and was much more dubious, not just because it increased the size of the Fed’s balance sheet but did little more than spark speculation on commodity prices.
Mehrling has identified two mechanisms through which ‘QE3’ is happening. The first, via the zero interest rate policy, is that private entities can borrow at zero and then reinvest that money in any asset with a positive return. (See, for instance, the recent rush to the Swiss franc). This is ‘privatized QE3‘ because it happens off the balance sheets of the Fed, via the expansion of private money – “private debts secured by the asset purchased.” The second mechanism, is via the expansion of eurodollars, or borrowing dollars from other banks that hold dollar reserves. Mehrling again: “The point is that QE3 is happening without any necessity for the Fed balance sheet to expand by a single dollar. It is happening on the balance sheets of other central banks.”
What’s the problem? Well, to begin with, as Mehrling himself observes, “The difference is that, since the Fed is not doing the trade on its own balance sheet, it has no control over which trades get made.” It can increase money supply, but it can’t tell people what to do with it. It certainly can’t force them to invest in creating things. And quite reasonably, given the absence of demand, corporations seem content to sit on their cash, or park it swiss francs or gold, rather than create jobs by investing in new production. As a way of dealing with unemployment, this is useless at best.
Worse yet, it seems like an aim here is to reboot the pre-crash system rather than change it. “The rationale behind lowering long-term bond yields is that it will enable homeowners to cut their borrowing costs, encourage greater borrowing and investment, while pushing more investors to leave government bonds and buy riskier assets.”
Invest in riskier assets? Cut borrowing costs for homeowners? This sounds like debt-financed asset-speculation, alongside debt-financed private consumption – ie the financial model of growth that got us into this mess. (And an incredibly inefficient and destructive way of providing people with homes, the only halfway decent thing to come out of this mess.) And, as Mehrling points out, since a lot of this QE3 mechanism is private in nature, “it looks like a repurposed shadow banking system” with the exception that the new asset on which to speculate has yet to be determined. (On shadow-banking, see this excellent piece by Kapadia and Jayadev). This is surely stimulus of the worst sort.
Finally, one defense of this kind of expansionary monetary policy is that it is a way of dealing with a balance-sheet recession in a way that also redistributes money. It helps correct balance sheets by inflating away debt, and inflating away debt helps households struggling to pay off credit cards and banks. As we’ve noted before, this narrative is decidedly flawed, because ‘debtor’ and ‘creditor’ are not uniform entities by any measure – they are certainly not the same as poor and rich, or worker and employer. But more to the point, inflating away credit is also a way of inflating away wages. The Census Bureau’s recent Income, Poverty and Health Insurance Coverage report notes that the real median household income has declined by 6.4% since 2007, and is 7.1% below its 1999 peak. Remember that is median income, with a bottom that includes many more unemployed than before – 4-10% more depending on how you measure. When you add in the unemployed and underemployed, you have a much more serious decrease in household income (nevermind wealth, which has seen even more serious declines). When there is inflation alongside wage stagnation, what are households to do? Borrow! This really does look like system reboot, except in much worse economic conditions, without an asset to speculate on (yet), and with households already deeply underwater. QE3 : US 1.