Ambrose Evans-Pritchard, in a provocative column, argues that the monetary authorities are not going retreating from QE, and that might not be a bad thing. But in its current form, it probably is.
His key argument is that we might as well stop pretending that QE is about lowering borrowing costs. It can and should be about monetizing debts. He further argues, agreeing with a recent speech by Adair Turner, former head of the FSA, that the world needs more fiscal stimulus:
The policy is elastic, for Lord Turner went on to argue that central banks in the US, Japan and Europe should stand ready to finance current spending as well, if push comes to shove. At least the money would go straight into the veins of the economy, rather than leaking out into asset bubbles.
Today’s QE relies on pushing down borrowing costs. It is “creditism”. That is a very blunt tool in a deleveraging bust when nobody wants to borrow.
Lord Turner says the current policy has become dangerous, yielding ever less returns, with ever worsening side-effects. It would be better for central banks to put the money into railways, bridges, clean energy, smart grids, or whatever does most to regenerate the economy.
Now of course there is a wee problem, since in the US, Congress is in charge of spending, and Congress and our deficit-loathing President are not at all interested in increasing deficit spending, even if they grokked that the Fed could monetize rather than have the Treasury borrow.
Pritchard points out that extreme monetization isn’t necessarily a bad thing. The usual suspect is Weimar Germany, but that isn’t a great comparable to much of anything, since the monetary expansion also took place when the productive capacity of the country had been severely impaired via the provisions of the Treaty of Versailles, due to the loss of territory and reparations in the form of coal. Evans-Pritchard mentions another example:
Less known is the spectacular success of Takahashi Korekiyo in Japan in the very different circumstances of the early 1930s. He fired a double-barreled blast of monetary and fiscal stimulus together, helped greatly by a 40pc fall in the yen.
The Bank of Japan was ordered to fund the public works programme of the government. Within two years, Japan was booming again, the first major country to break free of the Great Depression. Within three years, surging tax revenues allowed Mr Korekiyo to balance the budget. It was magic.
The Japanese overnight announcement, of a pedal-to-the-metal commitment to further expansion, produced a monster rally in the Nikkei. But how much further will the yen be permitted to fall? China was the key actor in driving the yen to the nosebleed territory of under 80 to the dollar. It’s now below 95. I’d hazard it needs to get to 110 to put the Japanese economy on a decent growth path. I’m not certain any of its major trade partners will stand for that.
Mind you, even some Fed doves are signaling that they’d like to taper off QE, but this appears to be based on undue optimism about the labor market. In 2011 and 2012, the pundits were optimistic about recovery prospects based on first quarter readings, only to have them fizzle. Has no one figured out that first quarter seasonal adjustments are large, and appear to be misleading in a low growth economy? And did no one get the memo that we have just started putting a big fiscal brake on the economy, thanks to payroll tax increases and the sequester? Economies do not turn on a dime, but the fact that the effect was not immediate seems to have lulled some commentators into thinking there will be no impact at all.
Evans-Pritchard goes through a long list of negative indicators: commodity deflation, falling M2 levels and velocity, US consumption holding up only by virtue of dangerously low savings rates, contrasted with too high savings rates elsewhere, particularly China, and misguided austerity in Europe.
I think the US will find it very hard to end QE, but for different reasons than most pundits assume. The conventional view is that the Fed will be loath to raise rates because it will produce losses on its bond portfolio. In reality, this does not matter, at least up to a very high level. Former central banker Willem Buiter warned of the dangers of central banks expanding their balance sheets, but he stresses that they were not equity constrained, since they could monetize any losses, but they were inflation constrained. If a central bank was in danger of violating its inflation mandate, it would need to go to its Treasury for a capital infusion.
But I don’t see that as the immediate impediment. There’s one that is more immediate. Recall how we got in this mess. Whether the Fed said so or not, one of its big motivations for ZIRP and QE was to boost asset prices, not just that of housing to create a consumer wealth effect, but also of financial assets to flatter bank balance sheets, boost their (apparent) capital levels and make them more willing to lend. What has happened is that the central bank has pushed investors into all sorts of risk assets. Do you think the Fed is going to be very eager to impose losses on people it just enticed into the deep end of the pool? The Fed has increasingly come to take a very asset-fixated view of the world, and it is likely to be loath to lower the price of financial assets, save very cautiously. Mind you, like Evans-Pritchard, I don’t think the state of the economy will warrant that any time soon, but that means the Fed will continue to pump up asset prices in an increasingly-desperate effort to get transmission to the real economy. Japan in the late 1980s was the first central bank to deliberately goose asset prices to encourage spending. We know how that movie ended.