Last month we entered the
sixth year of this crisis, although parts of the media seem determined to
continue calling it a ‘recovery’. Wishful thinking. We have been in continuous
crisis for half a decade. Doses of Valium and Prozac – called QE among central
bankers – have calmed nerves occasionally and given the false impression of
healing.
QE, or ‘quantitative easing’,
is, of course, the creation of massive new quantities of monetary units and
their targeted injection into financial markets for the purpose of manipulating
asset prices and interest rates, and of flooding the banks with extra free
reserves. QE is a dangerous drug. It is a hallucinogen. It can make you feel
better for a while but it won’t cure the disease. In fact, it makes you sick.
The global economy suffers from grave distortions that are the result of years
and decades of artificially cheapened credit: Overstretched banks, too much
debt, inflated asset prices, misallocated capital. Cheapening credit further –
and manipulating asset prices further – is, however, the MO of QE. QE
encourages additional borrowing and further balance sheet expansion.
QE – and zero interest rates
– is the policy equivalent of crack cocaine. It makes addictive. There is no
end to it.
I was reminded of this when
I opened the newspapers last Thursday for the first time in almost a month, and
learned that the Fed might be on the cusp of another round of QE.
“Fed Minutes Signal Action
Likely”, headlined the Wall Street Journal, “Fed shows a strong consensus for
action”, the Financial Times.
Whenever the policy elite is
promising more action you should get very concerned.
QE – to the bitter end
When compared to their peers
among the global oligopoly of state money printers, the Fed bureaucracy has had
a rather quiet spell over the past 12 months. The Fed only conducted some
balance-sheet neutral bond price manipulations (‘Operation Twist’) but
refrained from any money-printing worth mentioning. Since the crisis started in
July of 2007, when the bottom fell out from under the US subprime market, the
Fed has, of course, created a cool $1,900 billion in new money in
the form of bank reserves. Its balance sheet has more than
tripled. But most of this money was created during QE1 – after the collapse of
Lehman in 2008, when the Fed bailed out the US banking system by taking over
more than $1,000 billion of its mortgage exposure – and then during QE2 – when
the Fed created another $600 billion to manipulate the prices of US Treasury
securities. But in year 5 of the crisis – July 2011 to July 2012 – the monetary
base has remained unchanged, for the first time in any one-year spell since
July 2007.
Such impassivity is not
becoming for the most powerful central bank in the world, in particular when
the Bank of England is already on QE3, and the ECB has just expanded its
balance sheet by more than 50 percent. (Incidentally, the ECB, the pantomime
villain among international QE-enthusiasts because of its supposedly
Bundesbank-inspired hard-money line, created more money, at least exchange-rate
adjusted, since 2007 than the Fed: €1,800 billion. As I keep saying, when I look at the
world’s major central banks, I see sameness, not divergence.)
Bureaucrats can, of course,
not sit still for long. People might get the idea that they are useless and
that we don’t need them, or, heaven forbid, that their work is even positively
harmful. The bureaucrat cannot allow these concerns to emerge. Through ‘action’
he has to remind the public of his vital importance to society. By contrast,
private companies are ventures that are ultimately controlled by consumer
demand, and that are therefore usually limited in time. They emerge, grow and
prosper, decline and die when consumer tastes change or better competitors come
onto the scene. Not so the monopolistic state bureaucracy. It is built for
eternity. Regardless of how disruptive, harmful and distortive the central
banks’ ongoing money injections and cheap credit policies have been over the
years and decades, and how culpable the Fed (among others) has been in creating
and maintaining vast imbalances, the central bank bureaucrat has to go on with
his work. He can’t question his mission without questioning his own existence.
Part of the Fed’s official
mission is, famously, to boost employment. The notion behind this task – namely
that lasting private sector employment can be enhanced through constant money
injections and manipulations of interest rates – is utter economic nonsense.
However, it is the very raison d’etre of the Fed. That is their line and they
are sticking to it.
That QE3 would ultimately
come was clear from the moment that QE2 had been concluded. It was only a
matter of time. Yet, from the point of view of the central banker, it would be
a mistake to simply resume QE without orchestrating first a protracted and
well-publicised internal debate. Otherwise, the public could get the idea that
modern central banking was simply ‘money printing’ rather than a difficult,
complicated, and intricate affair that requires countless economic analysis and
careful fine-tuning.
The Fed’s present
deliberations seem to go something like this: There is a ‘recovery’ out
there, but it does not look ‘substantial and sustainable’ enough. Some higher
asset prices, lower interest rates, tighter risk premiums, or more generous
bank reserves – preferably, all of the above – could help the economy and make
sure that the ‘strengthening’ is ‘substantial and sustainable’. Let’s print
more money!
What to expect
I have no insights in what
precisely the Fed is up to, and frankly, I find the expert-discussions among
analysts on CNBC or elsewhere on the topic slightly degrading and
cringe-inducing, akin to watching an episode of ‘I am a celebrity, get me out
of here’. Do these experts realize how much we have moved away from capitalism?
These financial analysts often call themselves ‘economists’ when what they are
doing resembles much more the work of the Soviet-era Kremlin watchers who tried
to read between the lines of policy pronouncements and the tea leaves of the
Politburo.
For what it is worth, my
guess is the Fed will have to do more than the lame $600 billion they did last
time. And at some point they will have to also stop paying interest on the
massive excess reserves at the Fed to push more money into the economy.
What will the consequences
be? Will this be the straw that breaks the camel’s back? Will it push the
financial system over the edge? Will it finally undermine confidence in the
system? Will this trigger sell-offs in bonds and trigger currency meltdown? – I
doubt it. Not yet. We may have to wait a tad longer for this. But it will
undoubtedly add to the grave distortions in our financial system. The Fed’s
chosen assets will get a temporary boost, some well-connected financial firms
will make handsome windfall profits, and some of the economic data might
improve for a while. I also think that the deflationists out there, who expect
balance sheet shrinkage and drops in asset prices, will again be disappointed.
Another dose of Valium will probably keep asset prices supported and also
consumer and producer prices on an upward trend. All this new cash has to go
somewhere. The debasement of paper money will continue. Gold could do well.
Naturally, none of this will
end the crisis. It will certainly not kick off a ‘virtuous cycle’ of growth and
prosperity such as Bernanke
foolishly promised back in 2010 when he last engaged in QE. That this is
the one ‘stimulus’ that will finally put the economy on self-sustaining growth,
on the ‘substantial and sustainable strengthening’ the Fed demands, is
grotesque and simply laughable. This policy will simply cement the dislocations
and add more debt to our economies. It could inflate the government bond bubble
– the most dangerous of all bubbles – further, and allow the US government to
run even larger deficits for even longer (although, admittedly, the bond bubble
continued to inflate even in the absence of QE, due to private sector ‘safe
haven’ flows, although the bubble has also been supported continuously through
zero interest rates and ample bank reserves, both provided by the Fed). The
financial system will, on the margin, become even more dependent on ongoing Fed
support and ultra-low policy rates. This will make it impossible for the Fed to
ever reverse course.
The idea that all this
monetary madness is only temporary, only to help us get out of the crisis, and
that the central banks have an ‘exit strategy’ –a term that I have not heard or
seen in any discussion of central bank policy since spring of 2011! – is
getting less tenable by the day. There is no exit strategy. Not in the US, not
in the UK, not in the Euro Zone.
In Britain, the ex-central
bankers Blanchflower and Posen are demanding that the Bank of England, the
global QE champion, drops its ‘anguished
religious ethics’ over QE and finally buys a wider
range of financial assets, and not just government bonds. Germany’s
Spiegel-magazine this month reported that the ECB might establish upper yield
spreads for non-German government bonds and then defend them through its own
open-market bond-buying. Wherever you look, the same story: More money has to
be printed in order for the central bank bureaucracy to influence, distort and
manipulate an ever wider range of asset prices.
One day a sufficiently large
section of the public will realize that the central bank and the government
have no alternative to printing ever more money and taking on ever more debt.
The only way they know of how to ‘stimulate’ the economy is via cheapening
credit and encouraging more lending and borrowing. At some point, confidence
will evaporate, people will disengage from bonds and paper money, inflation
will rise (as money becomes a hot potato) and real interest rates rise even
faster (as bonds become hot potatoes, too). Nobody knows when that will be. But
we know one thing: the policy bureaucracy remains relentless in its efforts to
make the widespread price distortions, capital misallocations and the
gargantuan debt pile bigger. More interventions and market manipulations are on
the way. All of them are designed to discourage the liquidation of imbalances
and instead encourage more debt accumulation. The goal seems to be to make the
endgame as catastrophic as possible.
That is the one thing the
central bank bureaucrats and politicians will succeed in.
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