US Quantitative Easing: Policy enters the Malcolm X phase
Last night's decision by the US Federal Reserve signals a decisive end to the delay and denial that has characterised monetary authorities' response to the economic crisis. The FT is calling it "shock and awe"; to me it looks more like the beginning of the Malcolm X phase of the crisis. Malcolm famously told black America to defend itself "".
Just let me recap. As early as two weeks after the Lehman collapse, bond traders and economists in the City of London began telling me that there would have to be wholesale nationalisation of the banks and the large scale printing of money to stop this crisis. They badgered me, educating me in the process about the intricacies of quantitative easing. Some were Great Depression experts, some had been bloodied in Japan's lost decade. As a result I, among other journalists, began to raise the possibility that QE would have to be done.
To achieve QE you first of all have to cut interest rates to zero or near zero. This was achieved in the USA on 16 December and in the UK only on 5 March (the ECB is still way behind and I will come to that later). But in the USA, having created a platform for QE, Ben Bernanke shied away from it. Not for the first time in this crisis he proposed a seemingly elegant, complex and nuanced solution in its stead.
The Fed, he announced, would do "credit easing". Printing money in order to buy up the distressed assets of the banks, rather than - as the QE textbook says - to buy up government debt. He flew to London to make a heavily promoted dissing QE as the solution to this crisis. Economists began to doubt publicly whether Bernanke had understood the role of QE in alliviating the depression. One phoned me to point out that "in Bernanke's book on the Depression there is nothing under Q in the index".
The crucial difference with the Fed, said Bernanke then, was that it would not set a target for the amount of money to print, but concentrate on buying up the type of loans that would bring down the spread (ie the difference) between Federal borrowing, bank borrowing and company borrowing. Its initial plan was to spend $500bn in those famous "mortgage backed securities" and another $100bn on debt from Fannie & Freddie.
Last night's announcement, dramatically changes the game. In addition to another $750bn in MBS the Fed will now buy $300bn of long term government debt. Whether set as a target or no, the Fed's money printing operation now extends to $1.75 trillion - double the amount committed to the Obama fiscal stimulus. And it is not being done to have a subtle effect but a massive one.
In January just one member of the Fed voted for this form of "classic" quantitiative easing and was opposed by the rest. Last night's reversal of position was unanimous. The Fed also dropped language indicating "some financial markets have improved". The move, according to Barclays economists, is the equivalent of cutting 0.75% off interest rates, and leaves the government underwriting half the mortgage market and a third of the market for government debt.
The move is not only a victory for the "monetarist Keynesians" in economics who point out that only the move to QE put a floor under the collapse phase of the Great Depression in 1932 - it is something of a moral victory for the Bank of England. Having initially poo-poohed QE itself (and taken an age to get rates down to 0.5%) the Bank reportedly began to study textbooks and consult pro-QE economists in December.
Many saw Bernanke's LSE speech as an attempt to dissuade global monetary authorities from adopting the classic policy. If so the Bank of England ignored it, clearly under the impetus of the political will of the Treasury and Gordon Brown, who in my experience were never dogmatic about QE, simply cautious.
If (and it's a big if) Tim Geithner's new plan for a decisive cauterisation of bank losses proves convincing (it could be published as early as today), then both sides of the Atlantic we have a new narrative about the survival plan. And a very different policy from the one cobbled together in October.
But amid the relief it is worth noting that this could have been done earlier and it now leaves the ECB as the global naysayer. We already know the EU governments dislike the fiscal stimuli enacted by America, China, Japan and Brazil; the ECB has been much slower to cut interest rates and of course cannot itself "do" Quantitative Easing without the collaboration of national central banks.
There are of course respected economists who think QE is a disaster, who believe it will stoke up inflation, and that it probably won't work. They may be right.
But this was not the objection of those in power who resisted doing it. With hindsight their objections look like caution and an under-estimation of the seriousness of the problem. Now, with Mervyn King urging the G7 governments to take "any stake necessary" (code for "nationalise if you have to") the Malcolm X doctrine is taking hold.
Some have seen the US U-turn as the product of fear: "do they know something about the banks we don't?", ask market traders.
I see it as a victory for politics over the monetary policy elite. I am pretty sure Brown and Darling (and Treasury top civil servant Nicholas McPherson) were behind Britain's move to QE. I am also pretty sure Brown raised it with Obama on his trip to Washington, at a working lunch involving Lady Vadera and Second Permanent Secretary Jon Cunliffe. How it got from there to last night's stunning policy u-turn we probably have to wait for the history books to find out.
(PS. I am still in Riga, Latvia. More later on the situation here).
Comment number 1.
At 19th Mar 2009, Sasha Clarkson wrote:From what I've read about the Great Depression, QE stopped the banking system from collapsing, but did not itself promote recovery. Even with New Deal public works this took far too long.
I think part of the solution lies in adopting a Social Credit approach (after the movement started by Major Clifford Hugh Douglas). Money is merely an entitlement to consume goods and services. Much of this entitlement has been destroyed by the current crisis. If money is to be printed for "fiscal stimulus", why not give everyone spendable tax credit vouchers - tapered towards the poor who will actually spend it. And/or give British manufacturers a tax rebate in proportion to their sales - this might help redress some current imbalances.
There ARE historical examples of where printing money worked, because it was done intelligently, proportionately and in moderation. JK Galbraith cites,* amongst others, the examples of Maryland and Pennsylvania in the mid-eighteenth century.
At the moment, not only is there less money in the system, but its velocity has also reduced. IF we get an economic recovery, THEN taxes can rise to curb inflation.
*(in Money, Whence It Came, Where It Went)
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Comment number 2.
At 19th Mar 2009, barriesingleton wrote:MONEY
Paul, when all this began, I formed the opinion that no one knows what money is - no one can define it. Hence all the manipulation and calculation - not least - speculation - is done blind. (Very similar to modern cosmology, wherein terms like 'Dark Matter' are boldly applied.)
At that time I asked you if YOU knew what money is. Do you?
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Comment number 3.
At 19th Mar 2009, fairlopian_tubester wrote:#2 Barriesingleton
Perhaps there are lessons still to learn from John Law and the Mississippi Bubble.
A very apposite question. Money has gone from being a means to relate values of tangible "things", to figures on statements and balance sheets, to some spiralling configuration of electrons in semi-conductors and fibre-optic cables.
Dark matter is a good analogy - something invented ex nihilo because our accepted models of the beginning of the universe require there to be more mass than we can account for. (Simply accept that the speed of light is variable over time and the problems of red-shifting of galaxies and dark matter go away).
I realise I'm on heretical ground here, but I would question the objective reality of some of the amounts of money being talked about.
Can we appreciate what 1.9 trillion dollars actually means? It doesn't exist on paper (other than figures, that could be argued are just an abstraction) and we are running out of real measures that we can hold up.
Yet here we are, facing in a world crisis, sacrificing of the fruits of our working lives (and those of our children) to what may amount to a failed concept.
Imagine if "we" decided that currency was suddenly worthless. The small change in my pocket would still have a small residual value as scrap metal; the banknotes under my mattress could be pulped and recycled for a small amount; but what could I extract from numbers held in a transient medium?
Let's never devalue our capacity to think.
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Comment number 4.
At 19th Mar 2009, MrTweedy wrote:Private debt is becoming government debt.
Government spending now, and higher taxes later.
Will the government spending help private enterprise more than the increased tax burden will punish private enterprise?
Risk and reward. Will the return on the QE risk be positive or negative?
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Comment number 5.
At 19th Mar 2009, Hawkeye wrote:#1 Speed (the movie)
Ah, the velocity of money. Therein lies the heart of the problem. Perhaps the boom years were stimulated by an increased velocity of money. In simpler times we could only spend what we received in income (less tax, of course). And broadly speaking, as individuals our income has been relatively static from year to year.
The best way to increase the velocity of money is for individuals to repeatedly transact / re-sell an item they possess. Hence the last 20 years have seen quicker turn-around of house buying, reselling your car to buy a new one, share trading (derivatives??) etc. all speeding up the merry-go-round of money.
All those activities which involved excessive acceleration of expenditure have rapidly slowed since the credit crunch (disproportionately to other sectors, overall levels of decline in employment or economic output).
Perhaps we have been watching the wrong numbers all along. The arcane measures such as GDP per capita, Gvt debt, interest rates all distracted from the real forces at work in our economy.
Just as in the movie Speed, our juggernaut of an economy got itself into a situation where it HAD to operate at an almost unsafe speed; any slower, and KA-BOOM!!
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Comment number 6.
At 19th Mar 2009, chriss-w wrote:Whether all this monetary easing, or whatever you want to call it, will work is an open question: but since we are now set on this course we can only hope that it will.
Time will tell.
THere are however, two fundamental truths that no amount of economic theory can gainsay:
First, debts do not have the same value as money. All debts have to be paid back, and paid for, one way or another. Their only value (within the money supply) is the promise of repayment. This being so, borrowing to invest only works if the investment will generate a return that will, at least, cover the loan. The current spate of Government borrowing does not appear to have been invested in any revenue generating activity - and so the debt will have to be repaid out of current income.
Second, if there is twice as much money chasing the same amount of goods then, logically, the price of the goods will be double what it would otherwise have been.
The obvious conclusion, if this is correct, is that the current measures designed to pump money into the system will only work if something else occurs to stimulate demand: and get things moving. Otherwise we are just fueling inflation.
In the 1930's the something else was World War II.
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Comment number 7.
At 19th Mar 2009, allmyfault wrote:No, no, no, no.
This ship is holed; QE will not re-float her.
We cannot go back to the easy money we have had for the best part of a generation; we lived on our grandchildrens' inheritance (and much more besides).
In the modern parlance -'the business model is flawed.'
Wholesale change in the entire economic world is required -nay essential.
QE is only going to mean some cute insiders (who have the assets or funds to play with) are going to find a way to make a bucket-load, and the rest of us nuffink.
We just have to accept we are going to live through the pain.
It is bleedin' obvious, if you are in a hole, stop digging. If you are drowning in debt, stop taking out more credit cards.
Regards,
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Comment number 8.
At 20th Mar 2009, shireblogger wrote:Who's bonds are the Fed going to buy? Is this a monetary move or a balance sheet credibility move?
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Comment number 9.
At 21st Mar 2009, Twinkle_Venus_Nose wrote:#8
Countries that have large trade balance surpluses with United States. Now the Americans are repaying their loans by printing money, the biggest losers are the Chinese, Japanese and central banks across south-east Asia. This will no doubt lead to a wave of competitive devaluing of world wide currencies. You know, in my widest dream, I actually wonder whether the housing market will make a come back soon, since QE has made money almost equivalent to garbage.
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