How quantitative easing works — or doesn’t (Part Two: Debt and growth)
In the first part of this mental exercise we followed the wiki through the logic of Federal Reserve quantitative easing (QE) action up until the moment the authors of the entry embarked on a journey of patent misinformation. The authors of the wiki entry would have us believe that the banking cartel cannot create money unless it has sufficient reserves from which it can “grow” this money by lending some multiple of the currency it has on hand.
The wiki is absolutely wrong on this point: the banking cartel can create any amount of currency it needs, provided there is a demand for it, simply by making an entry into the account of the borrower, or in the account of the person from whom the borrower is making a purchase. In return for this entry, the borrower promises to pay the bank the amount of the loan with interest over some period of time.
Assuming our bare sketch of the “money creation process” is correct, this fictional money only comes into existence as a reflex of the same act by which it enters circulation, i.e., as the byproduct of an actual transaction. For example, it is the purchase and sale of a house that, simultaneously, brings about the creation of the fictional currency and puts it into circulation. Since, the banking cartel plays only a passive role in the transaction between the seller and the buyer of the house, its capacity to create money by entering a notation into the account of the seller cannot in any way increase economic activity.
Even a trillion dollars of excess reserves in the banking system cannot create home buyers; and, as Steve Keen has observed in a recent post, Deleveraging, Deceleration and the Double Dip, the increase in debt accounts for almost all economic growth in the post-war period.
For a long time I’ve focused on the contribution that the change in debt makes to aggregate demand, in the relation that “aggregate demand equals the sum of GDP plus the change in debt”. An obvious extension of that was that “change in aggregate demand equals change in GDP plus acceleration in the level of debt”—which would imply that change in unemployment is driven by changes in the rate of growth of debt.
Though I was aware of this implication of my analysis, I held off from testing it because I was concerned that this was pushing the data one step too far.
It turns out that I shouldn’t have been so cautious: the data well and truly supports this, on the surface, weird causal relation: the change in employment is strongly affected by the acceleration or deceleration of debt. This can give the paradoxical result that the level of employment can rise, even when the economy is deleveraging, if the rate of deleveraging slows. This phenomenon has driven the apparent stabilisation of the US unemployment rate (though of course the more meaningful U-6 measure has risen to 17 percent, and Shadowstats puts the actual unemployment level at 22.5 percent–well and truly in Depression territory), and it is highly unlikely that it will last.
My uncharacteristic timidity means that I have to doff my cap in the direction of the three economists who first published on this topic: Biggs, Mayer and Pick. They first showed the correlation between what they called “the credit impulse”—the rate of change of the rate of change of debt, divided by GDP—and both GDP and employment …
The chart below shows my confirmation of the relationship with the data on the annual change in unemployment in the USA and the annual rate of acceleration of private debt since 1955. The correlation is -0.67: a staggering correlation of a first and a second order variable over such a period, and across both booms and busts.
So, let’s step back and review:
The banking cartel can “create” money, and, then, use this fictional money to purchase something itself — the worthless fictional assets on its own books. Thus, quantitative easing, despite all the rather dense and complex literature produced by simpleton economists, consist simply in an exchange of unsellable worthless assets for equally worthless currency. On the one hand, it is merely the accumulation of these fictional assets in the hands of the State — the socialization of the toxic product of fictitious capitals. And, on the other, the replacement of these worthless assets on the books of fictitious capitals by equally worthless, but always spendable, currency. The entire point of the exercise, therefore, is not the increase of the “supply of money” or “lowering the rate of interest”, but, rather, purging bank losses resulting from the collapse of fictitious assets. These losses are transferred to the State and the scam is euphemistically renamed quantitative easing.
However, even with this outrageous scam the newly created fictional currency could not enter circulation without some mass of sheeple willing to bury themselves beneath an ever higher mountain of debt. It was for this reason that the first round of quantitative easing was accompanied by a number of so-called stimulative fiscal programs like “Cash for Clunkers” and the “First Time Home Buyers Tax Credit”.
The scam failed — miserably. Even with the transfer of fictional assets to Washington, and replacement of these fictional assets with newly printed fictional money, the accumulation of new debt encouraged by the banking cartel and the Messiah petered out as soon as the programs did.
As we will show next, the second round of quantitative easing by Washington and the banking cartel, dubbed QE2, will not be directed at the impossible goal of encouraging Americans to increase their debt burden when they are already incapable of servicing the debts they currently have. The logic of the current circumstances suggests that pool of potential borrowers must be expanded.
Quantitative easing version 2, we believe, has to result in the replacement of all other currencies by the dollar.