last time I "advised"
the FED on what to do was on Feb. 6, 2012. I "told" Ben not to
do QE3, and he didn’t. Instead, he did Operation Twist. This was the
second one of its type. The first Operation Twist occurred in 1961. The Twist
is an attempt by the FED to alter the shape of the bond yield curve. It
really doesn’t succeed. Considering the huge size of the debt market
and the arbitrage that occurs along the spectrum of bonds of different
maturities, it’s hardly to be expected that the FED is even capable of
altering the yield curve in any economically significant manner. Most of the
FOMC and its staff knew it would be futile (or should have known), because
the research on the effect of the 1961 operation concluded that it did very
little and accomplished nothing. This didn’t stop them in 2012. Why do
something so futile? My guess is they wanted to throw some kind of a bone to
those who were urging the FED to do more, including some on the FOMC itself.
They had little to lose and something to gain, which was to buy time and give
the appearance of acting.
order to make any kind of a respectable intellectual case for Operations
Twist of 2012, they had to have invoked Modigliani and Sutch’s work
that claimed that the bond market was segmented due to various legal and
institutional restrictions. The "preferred habitat" theory of the
latter says that bond investors are so accustomed to dealing in their
preferred maturity ranges that they won’t move outside them to take
advantage of interest rate differentials. It’s an unappealing theory
that requires people to overlook easy profits. An empirical paper written by Phillips
and Pippenger (published in 1976) rejects the preferred habit theory;
Pippenger was visiting at the St. Louis Fed at the time. A paper by Eric T. Swanson of the
San Francisco Fed estimates the effect of the latest Operation Twist to have
been only 15 basis points. We can conclude that Operation Twist again was
much for that. The months went by. The monetary base stabilized. I was
reasonably pleased that the FED had stopped monkeying around with the
markets. That was up until recently when a new push to do another QE or,
failing that, to do "something" emerged. I felt that the best thing
that could happen both for the financial markets and the economy, short of
the essential radical and ameliorative measures that seem as distant as ever
from the minds of policy makers, was no new shocks emanating from the central
bank and the government. Patience, patience, patience. Calmness, calmness,
calmness. Let the economy recover naturally. Let uncertainties dissipate.
Stop being overly fixated on every twinge in every economic indicator. Stop
interfering and stop yapping about every new number that comes out. If the
numbers could all be turned off before they reach the ears and desks of
policy makers, that would be even better. It would deprive them of the
catalyst that gets their control mentality going.
because of the FED’s bloated balance sheet and the difficulty they will
face reducing it ("exiting") if ever they do, I felt that, if
anything, they should take some steps in that direction now. Why not let some
air out of the bubble now by starting to alter the view that the Bernanke put
option is an ever-present reality? This (exiting) of course would create huge
commentary and even angst. In what quarters? Some in Congress, but even
moreso in the angst-ridden financial press, which, I have to say, seems to
cheer on the FED’s every action to do more, and more, and more. This
press (old, new, internet, blog, tv, radio and whatever) is a hall of mirrors
in which most everyone seems to speak up for the "markets" and
everyone else, claiming that they are demanding more QE, and
unless it happens, the world will fall. Then there are the spokesmen for
various investment outfits that want prices to rise. All these voices blend
into a self-fulfilling prophecy. Although the FOMC is to some extent
"above" these demands, I get the feeling that the members are not
nearly enough above it and insulated from it. They read commentaries on
markets and the economy and, being mortal, they are influenced by them.
if the FED intends to do more QE, what can it possibly accomplish? What did
the FED’s earlier moves do and not do, by whatever names one may wish
to call them, like quantitative easing, credit easing, or interest-rate
is a policy of buying bonds, usually government bonds, in order to increase
bank reserves. A policy of credit easing that involves buying the bonds of
some entity like Fannie Mae also increases bank reserves, and the same goes
for making a target interest rate lower. Inflation
by any other name is still inflation. Along with QE, the FED now pays
interest on bank reserves, so that it can sterilize or neutralize the effect
of a big buildup in bank reserves by paying enough interest that the banks
keep the reserves on deposit at the FED and do not lend them to each other.
The neutralization allows the FED to target credit to a favored sector like
mortgages, while stopping up the money creation side, if it so wills.
effects of QE depend on the level of interest rates. Bringing rates down from
6 percent to 3 percent via QE has more of an effect than when rates are 0
percent, start and finish, and the FED does an asset purchase. They also
depend on the condition of the financial markets, what the government is
doing, on the state of the economy, on various expectations, and on bank
regulatory policies. And they also now depend on the interest rate that the
FED pays on bank reserves.
the pre-2008 situation, monetary matters were usually much more simple
to understand brcause the FED was moving rates up and down while they were
well away from the zero mark. From 1945 to 2008, the FED often eased or
bought bonds (inflated). This was de facto QE, although the name came
only in the last few years. The banks then became flush. They increased their
mortgage, consumer and business loans. The housing sector responded. Building
quickened. Auto sales rose. Inflation in prices rose after awhile. The FED
helped the big banks by simultaneously stimulating the economy, but if the
economy became too frothy and price inflation too high, it had to slow it
down. So, conversely, the FED at times tightened (deflated) and the economy
slowed down or went into recession.
a war occurred, the situation altered somewhat. Price inflation would go up
more quickly and sharply. The FED would accommodate the government’s
borrowing. There were also trends in operation as these irregular ups
and downs occurred, namely, the FED kept inflating and government kept
growing and so did its debt, all on a long-term secular basis. These secular
trends accelerated when the currency was divorced entirely from gold in 1971.
The long-term QE was hardly benign, any more than its cyclical aspects were
benign in producing booms and busts.
was bad prior to 2008 because of its secular effect of aiding and abetting
big government, big government debt, big wars, and a big welfare state; and
also bad because of its production of business cycles.
QE does not have the same effects at all times. When the economy has a very
big recession such that the short-term interest rate gets near zero, the
impact of QE changes. It goes down. This happened in the 1930s. The monetary
base built up substantially in the 1930s, but unless banks turned around and
loaned out their excess reserves, the QE could not have much effect. Their
lending, in turn, depended on the kinds of factors I mentioned above, which
include government actions, the state of the economy, expectations, and
regulations on banks. The same goes for now, with an added factor that the
FED pays interest on reserves. QE may now be ineffective in stimulating
economic growth, but now it’s bad for other reasons.
and businesses do not have to borrow when banks are flush with
reserves. This creates slippage between a FED QE action that alters reserves
and its impact on the economy via bank lending. The slippage is due to all
these intervening variables that influence people’s behavior. The FED
is really operating very much in the dark. It can press down on its gas pedal
but it doesn’t know how the automobile will respond or even if it is
responding. The FED gets data about the economy but it doesn’t know
what effect its stepping on the gas pedal may have had. It continually does
research and so do speculators and academics, but no one knows for sure what
the causes and effects are. What should actually be done in this situation is
to end the FED and allow the market to produce money and credit, but that is
the FED became very active in 2008, its goal was to provide credit to member
banks. The banks ordinarily shifted bank reserves and short-term loans among
themselves, but the lending banks stopped lending when it became clear that
the borrowing banks might be insolvent because they held bad loans. The whole
levered fractional-reserve system seemed poised to collapse. Actually, it
wouldn’t have. The larger mis-managed and risk-prone banks may have
failed, but they could have been broken up. The better managed and solvent
banks would have picked up some of the pieces by buying loans of the bankrupt
banks at their market values. This restructuring was not allowed to happen,
because the big banks wouldn’t have it. Instead, the FED kept the whole
system going by making loans to banks. To these loans, it layered on QE1,
which flooded the system with reserves.
banks that were overextended and borrowing reserves were the larger banks,
including those in New York, while the lending banks were in the hinterland
(except for the upstart large regionals that become big). So that, exactly as
Gary North says, the FED acted as the tool of the big banks. The QE that it did
was not directed at big banks via the economy as in earlier decades. It was
aimed directly at the big banks and their balance sheets. It succeeded at the
goal of saving them, at least so far, and various intermarket spreads
declined in size. Some of these banks are still limping along, however.
short-term interest rates near zero and long-term rates having fallen, the
excess reserves of the banks pile up at the FED, which is paying interest on
them. (Actually this indirectly comes out of the pockets of taxpayers.) The
stimulative effect on the economy becomes nil in the sense that it is not
stimulated by more and more reserves piling up. The FED has gotten sellers of
some long-term bonds and MBS to sell them to the FED in exchange for
short-term debt (cash and reserves). They hold them because interest rates
are low. Banks may be willing to make loans, but there must be willing
borrowers. Without borrowers, there is no stimulus from QE. But as long as QE
persists and asset values in some markets are based on it, businesses are
uncertain of long term values. They don’t know when or if the FED will
exit and what will happen to prices when they do. The uncertainty adds to all
the other factors currently inhibiting business.
digress for one paragraph to say that there is altogether too much stress
placed upon credit as an engine of an economy. In an economy that lacks
credit facilities and financial intermediaries, developing them is very
important. But in a developed economy that already has such intermediaries
and knows how to create more if some of them fail, credit is the tail, not
the dog. Credit is finance, and finance is far less important in a developed system than is real investment. A
business places prime emphasis on its asset side: its products, its costs,
its competition, and its revenues. Financing is distinctly secondary. From
this perspective, way too much attention is given to the FED as an economic
force and the FED itself thinks of itself as far more significant than it is
on the real economy. By doing so and by catering to the more risk-prone
banks, what it succeeds in doing is nurturing speculative booms and then the
QE programs may be doing little or nothing when interest rates are very low,
but they still have the effect of shunting aside serious reform of the money
and banking system. They keep in place the big banks and their managements.
The large bonuses keep rolling in. A flawed system remains in place.
the big banks and/or financial markets from possible bankruptcy is not the
same as creating real investments, business investment, liquidating
malinvestments, moving labor into new occupations, creating new jobs and
economic growth. Does QE accomplish these goals? Let’s see.
did QE well before the FED did. In 2002, a team of the Bank of Japan’s
economists studied its
impact. This is a complex paper that has models and estimates of the
effects of QE in Japan. There are several cases that they analyze, and they
these results suggest that the effectiveness of the monetary base channel is
very uncertain, and we cannot find any certain route through which the
central bank can provide stimulus to the economy at zero interest rates.
sum, the results of this section suggest that the effectiveness, if any, of
the monetary base channel is highly uncertain and very small. We cannot find
any certain route through which the central bank can provide stimulus to the
economy at zero interest rates."
the zero bound of interest rates, the effects of the monetary base expansion
are "highly uncertain and very small." If you’d like to read
a much simpler discussion that yet produces the same kind of figures, then
see Hussman. For
a straightforward debunking that QE has any stimulative economic
impact at all, see Roche.
For a paper with findings similar to that of the
Bank of Japan, there is a Federal
Reserve study with these conclusions:
suggests some scope for quantitative easing to affect the supply of credit,
particularly during periods of financial stress. However, the overall effect
was measured to be quite small, so that eye-popping amounts of liquidity
would have been needed to achieve noticeable effects."
a detailed verbal (readable) evaluation of the QE
program of the Bank of England, see Colin Ellis.
told, there are few signs that the BoE’s asset purchase programme has
had much impact on the real economy to date. Financial markets have improved
– but that appears to have largely reflected global developments,
rather than the Bank’s purchases."
literature to date is uniform in its appraisal that QE doesn’t
stimulate an economy when interest rates are near zero or very low. Such an
economy can recover naturally, of course, if given time.
awhile, studies will appear about the effects of QE1 and QE2 on the American
economy. We have already heard Janet
Yellen (who is the Vice Chair of the Board of Governors of the Federal
Reserve System) claim that QE1 and QE2 created 1.8 million jobs through 2011
and will create 1.2 million more in 2012. She essentially attributes all
the job growth in the economy to the FED’s asset purchases. Given what
we know about Japan and the United Kingdom, what she claims is ridiculous. I
view Yellen as wholly untrustworthy and a rampant inflationist. For an
example of her views, see here.
should the FED do now (beside going into Chapter 13 bankruptcy)? It should do
no harm. Sadly, this is actually asking a lot! There are too many activist
and impatient Keynesians in the FED.
FED should not lower the interest rate on bank reserves in order to
stimulate lending. That will have an horrendous signaling effect on markets,
leading to higher bubble prices. We do not need more bubbles. It should not
start up another QE program. This will be useless and could likewise unleash
a run against the dollar.
would be nice if the FED would ask Congress to remove its dual mandate and
replace it with a single mandate of price stability. Otherwise, an
unbelievable crew of naive FED inflationists who are in positions of FED
power, Keynesians all, is anxious to turn the FED into an inflation engine
beyond anything ever before imposed on the American people, Revolutionary War
finance excepted. These dangerous central bankers need to be stopped before
they come up with some new harebrained scheme.
wrote a letter to a Congressman that surfaced the
other day and he wrote "there is scope for the Federal Reserve to ease
market conditions." This can be interpreted in a dozen different ways.
Maybe the latest
released minutes of the FOMC have a clue or two. We learn that
also exchanged views on the likely benefits and costs of a new large-scale
asset purchase program. Many participants expected that such a program could
provide additional support for the economic recovery both by putting downward
pressure on longer-term interest rates and by contributing to easier
financial conditions more broadly."
bunch of people in the room view QE as effective and think QE3 will stimulate
the economy. Don’t they read the research that has been done?
is then a passage expressing the concerns that other participants had about a
new QE program, such as its low efficacy, its transitory effects, its effect
on the balance sheet making it even more difficult to normalize it, and that
such a QE "program could increase the risks to financial stability or
lead to a rise in longer-term inflation expectations". This group makes
more sense to me and is, I believe, more in line with both reality and
that is followed by a comeback by the "many" inflationists who
propose that if the program is kept flexible, to be adjusted "in
response to economic developments or to changes in the Committee’s
assessment of the efficacy and costs of the program," this answers to
the objections and reservations of others.
the FOMC discussion’s give and take reveals that it is flying blind. As
a group, they literally do not know what they are doing. They don’t
know the effects of their actions. This is seat of the pants monetary manipulation,
and they don’t suffer if things go wrong. They just move back into
academia or a consulting job. The discussion reveals the weaknesses of a
centralized committee approach to managing a nation’s money supply and
allowing a bunch of economists to make decisions, who cannot agree with one
another, who don’t know what’s going on, and who do not face
sanctions when they blunder.
The inflationists are entirely ad
hoc in their approach. That is part of what being "flexible"
means in this context. To them, they are playing a chess game with the
economy. They will wait and see what moves their opponents make and then
react. They have no real plan, unless it be "inflate and see". The
other part of such a flexibility is that it becomes
a ticket for open-ended inflation at the discretion of the FOMC.
the taxation of transactions in gold and silver. End the legal tender status
of the Federal Reserve’s dollar. End the laws that prevent private
coinage. Divide banks into those that provide 100% depositories for money and
those that do not. End the FED’s privileges. Separate the FED from the
government. Allow banks to offer silver and gold accounts. Distribute the
gold stock to Americans.