Quantitative easing may be a dead end for the Federal Reserve … So, Washington will be coming for you to foot the bill
According to James Rickards, the Federal Reserve Bank likely has no way to exit from its money printing effort known as quantitative easing:
Disasters sometimes sneak up in small steps, each of which appears unthreatening at the time but which cumulatively spell collapse. The Fed is leading the United States to ruin in ways that are claimed to be well intentioned and benign viewed in isolation but which take us finally into a locked room reminiscent of the Sartre play “No Exit.”
He takes us through the steps of the process by which the Federal Reserve has already found itself in a quagmire, and insists on pushing deeper into it:
How does the Fed print money? It’s easy; they simply buy bonds from the market and credit the seller’s bank account with electronic cash that comes out of thin air. When they want to reduce the money supply, they do the opposite; that is, they sell bonds and the buyer’s bank account is reduced by the sale price and that money disappears. So, printing money is just a massive program of bond purchases. The Fed intends to concentrate the current bond buying program in the intermediate sector of 5 to 10-year maturities.
A massive program of bond purchases, yes. But, more important, a program of swapping fictitious assets for fictitious money in a series of fictitious transactions that superficially resemble real transactions but result in the exchange of no real economic values. There are, for instance, the utterly worthless purchases of mortgage backed securities and various junk from the failed financial sector. The intricacies of this garbage need not be understood in order to understand Rickards’ point: it is all junk, worthless, pieces of paper that have not an iota of value, and which will never be worth anything ever into the distant future beyond the point where the planet itself is no longer habitable.
The point is, none of this crap will ever be sold again for more than a fraction of its face value. It is toxic. You could back a truckload of it up to a recycling plant and walk away with no more than a week’s worth of groceries. And, the Fed has so much of this crap on its books, if it actually had to state its market value, the bank’s balance sheet would implode:
As a result, the Fed is coming to resemble a highly leveraged hedge fund with an inverted pyramid of risky, volatile and junk debt balanced on a slim layer of capital. Recall the Fed owns the Maiden Lane portfolio of junk from Bear Stearns and $1.4 trillion of mortgages whose value is in serious doubt because of strategic defaults, lost notes and halted foreclosures. Treasury notes may be of good credit quality if you don’t mind getting paid back in debased dollars but even Treasury notes have market risk. If interest rates go up, the value of Treasury notes goes down; it’s that simple. The Fed is taking both credit risk and market risk on its balance sheet in unprecedented amounts.
Under QE2, the Federal Reserve hopes to double down by adding Washington debt to its mix of toxic sludge. And, this is where the game gets really interesting.
To buy Washington’s debt, and force down interest rates, the Federal Reserve essentially has to outbid all other players in the public debt market. It can do this simply by entering the required digits at a computer terminal — and keep entering them until every other bid is taken out. At the end of the day, the Fed has pushed everyone else out of the market by paying more for Washington’s debt than anyone else in their right mind would be willing to pay.
When people say the action of the Federal Reserve is nuts — because the Fed is deliberately paying more for the debt than it is worth, and because the Fed is inundating the economy with worthless currency — the Fed has two responses:
When critics raise the issue of mark-to market losses, the Fed has a simple answer, which is that they will hold to maturity. The Fed does not have to mark to market; they can simply hold the assets to maturity and collect the full proceeds from the Treasury or other issuers. Just ignore for the moment the fact that some of the junkier assets and mortgages will not pay off, ever. That’s years away; for now, let’s just give the Fed the benefit of the doubt and say that mark-to-market losses don’t matter because they don’t have to sell.
Critics also raise the issue that this much money printing will result in inflation at best and maybe hyperinflation if velocity takes off due to behavioral shifts. The Fed is also very reassuring on this point. They say not to worry because at the first signs of sustained and rising inflation they will reverse course and reduce the money supply by selling bonds and nip inflation in the bud. But also note that the world in which the Fed wants to sell the bonds is also a world of rising inflation and therefore rising interest rates. This is the world of huge mark to market losses on the bonds themselves.
To the first concern the Fed says, “Oh, sure we’re paying too much for this debt, but we will just hold onto it until we can sell it without taking a loss.”
To the second concern the Fed says. “Oh, sure this will cause inflation, but we can fix that by selling this debt and soaking up the excess money.”
Rickards isn’t buying this bullshit. If the Fed is successful and inflation takes hold, he points out, interest rates will be rising — and if interest rates are rising, the price of Washington’s debt will be collapsing. The Fed will suffer massive losses if it tries to sell the debt to siphon off the excess money in the economy that is driving up prices:
The Fed is saying don’t worry about mark to market losses because we will hold the bonds. The Fed is saying don’t worry about inflation because we will sell the bonds. Both of those statements cannot be true at the same time. You can hold bonds and you can sell bonds but you can’t do both at once. You will want to sell when rates are going up but that’s when losses will be the greatest. So the time when you most want to sell is the time when you will most want to hold. The Fed may say they can finesse this by selling shorter maturities only to reduce money supply and holding onto longer maturities. But that just further degrades the quality of the Fed’s balance sheet and turns it into a one-way roach motel for highly volatile and junk assets.
Monetary policy is dead — stick a fork in it — and so is the Fed:
So, here’s the bottom line on money printing, or QE if you prefer. If nothing happens, the whole thing was a waste of time. If inflation takes off, the Fed will have to choose between holding bonds and letting inflation get worse or selling bonds and going bankrupt in the process. Since no entity goes down without a fight, the Fed will naturally hold the bonds and let inflation take off. Do not ask about the exit strategy from QE; there is no exit.
End of story, right?
No! Not by a long shot. We’re just getting to the really really interesting part — the part where you get royally screwed.
You see, even if the Fed cannot exit from its quantitative easing program, there is still all this fictitious money sloshing around the economy, driving up prices, and bidding up everything that isn’t locked down. The Fed may be effectively frozen, but there is still a way to drain the economy of all that excess money.
Washington simply takes it from you. Your elected officials down in Washington can perform a type of monetary policy to drain all the excess liquidity from the system by raising your taxes and cutting the programs you rely on. According to Billy Mitchell, a prolific modern monetary economist who writes at Billy’s blog:
It is a good practice to think of taxes as just draining liquidity from the non-government sector reflecting the Government’s desire for that sector to have less spending capacity.
Now, you know why Washington is debating deficit reduction in the middle of the worst recession since the Great Depression: if the Federal Reserve is able to get the debt creation process moving again, and the economy starts to expand, they intend to withdraw the excess liquidity in the economy by taking it from you.
You will pay more taxes.
You will pay higher prices for everything.
You will retire when you are dead.
The bottom line for you: you will be forced to work longer hours for less pay just to keep the same standard of living, because inflation will be rampant, and your after tax income will be plummeting.
They assume that by the time you figure this out it will already be too late for you to do anything about it.
If Washington gets its way, you are going to suffer the most massive wage income collapse in human history.
Quantitative easing embodies a number of insoluble contradictions. First, that too much work expresses itself as too little employment; second, that unprecedented abundance expresses itself as scarcity; third that the capacity to produce far in excess of human needs expresses itself as poverty; fourth that too much debt expresses itself as too little money.
There is not too little employment, but too much of the labor employed is wasted on unproductive and superfluous activity. There is not a scarcity of goods, but a scarcity of profitable demand for those goods. There is not too few means of production, but too little of it is employed to meet human needs. There is not too little money, but too little of it is created in the form of dollar denominated debt.
Quantitative easing, allegedly undertaken to eliminate unemployment, poverty, scarcity, and debt, must result not in the diminution of these evils, but in their aggressive expansion.
Since, in the simple-minded world of economists, economic growth is induced by the expansion of the quantity of money in circulation — and since this new money enters circulation only as a reflex of the same process by which it is created, i.e., by the creation of new debts — the elimination of poverty is irrationally predicated on its further expansion; on the further indebtedness of the mass of society.
In the same Orwellian fashion, the economist explains that poverty can be eliminated by progressively diverting present public and private income to the servicing of previously accumulated debts; and, that the scarcity of goods can be eliminated so long as companies relentlessly shutter their factories and eviscerate their workforces.
The stupidity of economic policy reaches its logical expression in the mind-numbing, logic defeating, assertion by Saint Paul Krugman that these social evils can be remedied only if the money held by the great mass of society is relentlessly devalued by Washington:
The Case For Higher Inflation
Olivier Blanchard, normally at MIT but currently the chief economist at the IMF, has released an interesting and important paper on how the crisis has changed, or should have changed, how we think about macroeconomic policy. The most surprising conclusion, presumably, is the idea that central banks have been setting their inflation targets too low:
Higher average inflation, and thus higher nominal interest rates to start with, would have made it possible to cut interest rates more, thereby probably reducing the drop in output and the deterioration of fiscal positions.
To be a bit more precise, I’m not that surprised that Olivier should think that; I am, however, somewhat surprised that the IMF is letting him say that under its auspices. In any case, I very much agree.
I would add, however, that there’s another case for a higher inflation rate — an argument made most forcefully by Akerlof, Dickens, and Perry (pdf). It goes like this: even in the long run, it’s really, really hard to cut nominal wages. Yet when you have very low inflation, getting relative wages right would require that a significant number of workers take wage cuts. So having a somewhat higher inflation rate would lead to lower unemployment, not just temporarily, but on a sustained basis.
The irrationality of the post-war capitalist economic system is presented in its unvarnished form by our Saint Paul in this excerpt: Employment can only increase under conditions of exchange whereby workers receive nothing for their additional hours of work; output can only rise if this output does not result in any additional consumption by the great mass of society; economic growth can be achieved through a massive infusion of new money into the economy only if that new money reduces the purchasing power of the existing money in circulation.
Quantitative easing meets these three conditions. Washington injects billions of new dollars into the economy which does not create any new output but only drives up money demand for the existing output — thereby reducing the purchasing power of money already in circulation. To the extent this new money actually increases employment, the new wages paid out are only money or nominal wages, since this money does not imply the creation of any new goods. Since no new output accompanies the creation of this new money, and since the successful injection of money into the economy presupposes the expansion of new debt, whatever new output emerges from this new employment rests on the absolute capacity of the worker to convert an increasing portion of his wages into a mere income stream to service this new debt.
Quantitative easing, therefore, is not a new policy, but the expression of the failure of the existing policy whereby the value of wages is continuously depreciated as capitals seek to forestall the fall in the rate of profit. It presupposes the debt saturation of the existing labor force, whose wages have already been exhausted by debt service. It is no longer merely the expansion of debt that Washington seeks, it is the expansion of debt denominated in dollars — to the exclusion of the debt, and, therefore, of the creation of monies, denominated in all other currencies.
Thus, from Tim Duy at the blog Fed Watch, we read this:
The Final End of Bretton Woods 2?
The inability of global leaders to address global current account imbalances now truly threatens global financial stability. Perhaps this was inevitable – the dollar has not depreciated to a degree commensurate with the financial crisis. Moreover, as the global economy stabilized the old imbalances made a comeback, sucking stimulus from the US economy and leaving US labor markets crippled. The latter prompts the US Federal Reserve to initiate a policy stance that will undoubtedly resonate throughout the globe. As a result we could now be standing witness to the final end of Bretton Woods 2. And a bloody end it may be.
Rather than a reliance on US financial institutions to intermediate the channel between foreign savers and US households, a modified Bretton Woods 2 – Bretton Woods 2.1 – relied on the US government to step into the void created by the financial mess and become the intermediary, either by propping up mortgage markets via the takeover of Freddie and Fannie, or the fiscal stimulus, or a dozen of other programs initiated during the financial crisis.
In essence, a nasty surprise awaited US policymakers – after two years of scrambling to find the right mix of policies, including an all out effort to prevent a devastating collapse of financial markets and a what Administration officials believed to be a substantial fiscal stimulus, the US economy remains mired at a suboptimal level as stimulus flows out beyond US borders. The opportunity for a smooth transition out of Bretton Woods 2 was lost.
How has it come to this? To understand the challenge ahead, we need to begin with two points of general agreement. The first is that the US has a significant and persistent current account deficit, which implies that domestic absorption of goods and services, by all sectors, exceeds potential output. In other words, we rely on a steady inflow of goods and services to satisfy our excess demand, a situation we typically find acceptable during a high growth phase when domestic investment exceeds domestic saving. The second point of agreement is that high unemployment implies that actual output is far below potential output. We clearly have unused capacity.
The collapse of Bretton Woods 2 was predictable once American workers became saturated with debt, and were unable to service existing obligations, much less expand them. But, this debt sustained the off-shoring of American industry to the low wage exports platforms of China, Brazil and Asia — which, in turn, created the trade deficit. With the debt saturation of the American worker, the entire underpinning of the system, whereby American companies moved their facilities overseas and imported their goods back to the United States to sell to an increasingly impoverished population, is now threatened by the ever declining consumption power of now jobless Americans.
The breathtaking absurdity of the systematic impoverishment of the very population whose consumption is essential to the functioning of the economy — wherein the worker is let go, his job is moved to China, yet he is expected to have the means to then purchase the product he now no longer makes — which rest on conditions that are clearly the product of a psychotic mind — that his wages are to be substituted by extension of easy credit — can only be explained by the incomprehensible delegation of the management of the process of social production to madmen who believe real wealth can be created by changing the quantity of dancing electrons at a computer terminal.
But, this is where the madmen have their last laugh: “Who,” they respond, “is talking about real wealth? We are not talking about real wealth, but social wealth, and this social wealth — this power over billions, expressed as the power to command labor — is denominated in many different currencies. It is not our intention to create real wealth, but merely social wealth!”
We are, it appears, not in the real world, but trapped in the nightmarish world of the insane, the sociopath:
Put simply, the Federal Reserve is positioned to declare war on Bretton Woods 2. November 3, 2010. Mark it on your calendars.
So perhaps Bretton Woods does not end because foreign governments are unwilling to bear ever increasing levels of currency and interest rate risk or due to the collapse of private intermediaries in the US, but because it has delivered the threat of deflation to the US, and that provokes a substantial response from the Federal Reserve. A side effect of the next round of quantitative easing is an attack on the strong dollar policy.
The rest of the world is howling. The Chinese are not alone; no one wants it to end. From Bloomberg:
Leaders of the world economy failed to narrow differences over currencies as they turned to the International Monetary Fund to calm frictions that are already sparking protectionism….
….Days after Brazilian Finance Minister Guido Mantega set the tone for the gathering by declaring a “currency war” was underway, officials held their traditional battle lines. U.S. Treasury Secretary Timothy F. Geithner and European Central Bank President Jean-Claude Trichet were among those to signal irritation that China is restraining the yuan to aid exports even as its economy outpaces those of other G-20 members.
“Global rebalancing is not progressing as well as needed to avoid threats to the global economic recovery,” Geithner said. “Our initial achievements are at risk of being undermined by the limited extent of progress toward more domestic demand- led growth in countries running external surpluses and by the extent of foreign-exchange intervention as countries with undervalued currencies lean against appreciation.”
At the same time, officials from emerging economies including China complained that low interest rates in the U.S. and its developed-world counterparts mean investors are pouring capital into their markets, threatening growth by forcing up currencies and inflating asset bubbles. The MSCI Emerging Markets Index of stocks has soared 13 percent since the start of September…
…“Near-zero interest rates and rapid monetary expansion are geared at stimulating domestic demand but also tend to produce a weakening of their currencies,” Mantega said Oct. 9. As a result, developing countries will continue to build up reserves in foreign currency to avoid “volatility and appreciation.”
Consider the enormity of the situation at hand. The Federal Reserve is poised to crank up the printing press for the sake of satisfying their domestic mandate. One mechanism, perhaps the only mechanism, by which we can expect meaningful, sustained reversal from the current set of imbalances is via a significant depreciation of the dollar. The rest of the world appears prepared to fight the Fed because they know no other path.
Bad things happen when you fight the Fed. You find yourself on the wrong side of a whole bunch of trades. In this case, I suspect it means that Bretton Woods 2 finally collapses in a disorderly mess. There may really be no other way for it to end, because its end yields clear winners and losers. And the losers, in this case largely emerging markets, [are] not prepared to accept their fate.
Stated simply, the collapse of all other currencies is being engineered by Washington, because Washington has no other choice. If it is to continue feeding off the unpaid labor of others, the cartel in Washington must expand the pool of potential debtors. The inherent contradiction expressed in QE can be temporarily held at bay only by the collapse of the dollar’s competitors.
Bottom Line: The time may finally be at hand when the imbalances created by Bretton Woods 2 now tear the system asunder. The collapse is coming via an unexpected channel; rather than originating from abroad, the shock that sets it in motion comes from the inside, a blast of stimulus from the US Federal Reserve. And at the moment, the collapse looks likely to turn disorderly quickly. If the Federal Reserve is committed to quantitative easing, there is no way for the rest of the world to stop to flow of dollars that is already emanating from the US. Yet much of the world does not want to accept the inevitable, and there appears to be no agreement on what comes next. Call me pessimistic, but right now I don’t see how this situation gets anything but more ugly.
If we are generally accurate in the analysis presented above, the coming period will see a series of currency crises sweeping the globe, as one currency after another falls victim to the Federal Reserve Bank’s quantitative easing program. The unsustainable trade deficits of Bretton Woods 2, which were only made possible by the now unsustainable debts borne by American working people, can only be resolved one of two ways: either these imbalances must give way to a global depression centered in China and other surplus generating exporters and the accompanying devaluation of their dollar denominated assets. Or, they must accept the increasing dollarization of their economies.
They do not have much time to decide.
The loss of sovereign control over the national economy is experienced by every nation once the production process becomes globalized. While the United States experiences this as a relative loss of policy independence — it can no longer exercise control over its national economy without exercising control over monetary policy within the world market as a whole — for every nation other than the United States this loss is absolute.
Those who mourn this loss on the part of Brazil, Greece, Ireland, China, etc. are fools, who no more understand the nature of sovereign economic policy than they do capital in general. For these progressive simpletons, national economic policy exists in some sterile vacuum where there is no conflict between working people and a class of parasitic blood-sucking vermin who wage war against them with every tool at its disposal.
Sovereign national economic policy has never been anything more than a weapon employed by national capitals to bludgeon the working classes of every country into submission. It has always been a weapon by which these national capitals have sought to increase the extraction of unpaid labor from working people, as well as from the working classes of their trading partners.
What is it exactly that you are mourning?
The wanton brutality and naked economic violence with which the Argentine national capital, in collusion with Washington and the IMF, plunged the working people of that nation into abject poverty — and left them turning over garbage for something they could sell to recyclers?
The vicious and unconscionable assault on the working people of the Soviet Union as the elite managers purloined the national infrastructure and turned over the population to the tender embrace of KGB thugs, and, US and European finance capital?
As that failed Tea Party hopeful Christine O’donnell might say: “You muthafuckin’ leftists had better put your man-pants on!”
All that has occurred here is that the collusion between national capitals — as, for instance, in the case of Chinese state capital — and Washington, that marked the long period of economic expansion prior to this crisis, has, with this crisis, broken down as former partners now seek to minimize their share of the losses created by it.
This battle, as in every battle of this sordid kind, is decided by the advantage of position and historical circumstance — which advantage lies with Washington owing to the fact that the previous period of collusion (in which Chinese manufacturers fed the hungry maw of American consumption) was made possible by the dollar’s role as world reserve currency. So long as the United States owned the world reserve currency it could run unlimited trade deficits and, thus, act as consumer of last resort for ill-made, defective, and dangerous Chinese output.
The entire history of the previous expansion consists of the transfer of worthless American debt assets to nations that, in turn, transferred their badly made manufactured products to the US in return. This expansion was only a veil behind which these nations concealed their actual loss of sovereign economic policy with a flood of worthless dollar denominated dancing electrons.
The predatory, vile, and despicable nature of this collusion is only gradually being uncovered when, as in the case of Greece, billions in now worthless public debt is being used to extract a still greater magnitude of unpaid labor from the European working classes, and as working people, so deeply damaged by the meat-grinder of endless sweatshop labor, would rather throw themselves from the rooftops of Chinese factories than endure one more minute of this relentless torture.
The unconscionable press of globalization has broken the bodies of millions of working people, left them destitute and mired in poverty, and rendered them depraved of both moral shame and social empathy — it has turned Eastern Europe into the brothel of Germany, France and Britain, promoted the sale of Southeast Asian children to sexual predators, and given birth to Africa’s latest contribution to the lexicon of inhumanity: the blood diamond. A year after Haiti was demolished by an earthquake her working people remain in tent cities surrounded by human waste and cholera infested waters.
Is there any wonder that after the collapse of global production we now find this little snippet from today’s Financial Times in which London, in a fit of Tea Party-inspired austerity, proposes to press the unemployed into work gangs:
Unemployed face compulsory labour
By Jim Pickard, Political Correspondent
The long-term unemployed could be forced to carry out manual work to retain their benefits under plans to be announced within days.
Iain Duncan Smith, work and pensions secretary, will announce the plan as part of his welfare shake-up to be set out in a white paper on Thursday.
Under his idea, those who have been out of work for a certain time may have to take up four-week placements – at 30 hours a week – to get them used to having a full-time job. If they refuse to take the programme, or fail to complete it, their jobseekers’ allowance of £64.30 a week would be stopped for three months or more. The jobs are likely to be provided by a mix of private companies, councils, charities and other voluntary groups.
However, it is not clear yet whether officials have worked out the potential cost of the scheme, which will inevitably involve a high level of bureaucracy and administration.
The US-inspired idea is part of major reforms by Mr Duncan Smith to reduce the welfare bill and cut a “culture of dependency” in some parts of the country.
”The message will go across; play ball or it’s going to be difficult,” Duncan Smith told the Telegraph newspaper. “One thing we can do is pull people in to do one or two weeks’ manual work — turn up at 9am and leave at 5pm to give people a sense of work, but also when we think they’re doing other work.”
However, the minister will stop short of the American system where benefits are withdrawn entirely after a certain period.
The plan is part of a wider scheme to simplify the complex web of benefits available, to reduce errors and inefficiencies.
His new “universal credit” will roll benefits such as housing, income support and incapacity into a single welfare payment. Key to this is a desire to prevent a “dependency trap” whereby it is more lucrative for some to stay out of work.
Mr Duncan Smith has said the existing system was regressive and not giving people the right incentive to work.
”We will shortly be bringing forward further proposals on how to break the cycle of dependency blighting many of our communities and make sure work always pays,” a spokeswoman for the Department for Work and Pensions said.
With France and Greece extending the working lifetime, with Spain and Portugal introducing “flexibility” in work rules, and government around the world selling public assets to balance their budgets, how soon will a proposal surface for a return to the virtuous manners of the Victorian Age, and the resurrection of the workhouse.
Here is the future of national economic policy — here is the future of progressive economic thought: the unyielding press to reduce consumption to the narrowest possible confines in order to fill the coffers of a bankster mafia cartel headquartered in Washington.
Although world market prices tend to be denominated in dollars, it would be a mistake to conclude that the formation of world market prices is a consequence of the use of the dollar in transactions. Rather, world market prices are increasingly denominated in dollars because the production process has become globalized. Since the price of a good is only the expression of the value (or, socially necessary labor time) embodied in the good, which can never be directly measured, the value of a good expresses itself in the material bodily form of some other object whose use is to serve as money.
But, the world market is composed of dozens of countries each having their own national currency. Given the myriad of currencies, the denomination of goods in the currency of the dominant nation simplifies the task of comparing production costs across nations, each nation having its own specific conditions of production.
By quoting the cost of labor power and commodities in a single currency, global corporations can more accurately compare their costs of production, and measure their return on investment using a single yardstick. This single yardstick then becomes the preferred unit of measure and denomination of prices.
This is necessary to point out because of a persistent myth spread by economists that the object serving as money is money owing to some legal requirements established by the State — for example, this view holds that dollars are money because they are declared legal tender by the federal government of the United States.
The laws of the United States apply only to the United States; they do not apply to France, Brazil, Senegal, Bhutan or any other nation. Yet, despite this apparent limitation on the reach of US law, it does not matter in the least how many euros, pounds, yen, yuan, or reals you have in your possession when you go shopping in the great global mall of the world market; the world market prices of goods are denominated and payable in dollars. For example, if Senegal wishes to buy 100 barrels of oil, its currency, the CFA Franc, is useless unless it is first converted into dollars. This requirement is imposed on Senegal by existing world market conditions without respect to the laws on its books concerning what legally constitutes money.
In the previous chapter, we showed that should the Bank of England undertake to impose a price inflation rate of 2 percent a year on the British economy the policy would ultimately fail to prevent deflation because, frankly, there is no such thing as a British economy, and, in any case, the price of goods are not determined within the confines of Great Britain but within the world market as a whole. Yet, the myth of the national economy persists as a habit of thinking although national economies have long since been replaced by a global production process.
If the Bank of England were to take the total supply of pounds and double it — or cut it in half — the net effect on real prices for output would be zero. Whatever inflation the Bank of England were to generate in domestic prices would be offset by the decline in the exchange rate of its currency.
We want to be clear that what we said for the Bank of England also applies to the Federal Reserve of the United States: an attempt by the Federal Reserve to create inflation of 2 percent in the US economy will have exactly the same effect on the dollar as it has on the British pound. As in the case of Britain, should the Federal Reserve Bank undertake to impose a price inflation rate of 2 percent a year on the American economy the policy would ultimately fail to prevent deflation because, frankly, there is no such thing as an American economy, and, in any case, the price of goods are not determined within the confines of the United States but within the world market as a whole.
Likewise, if the Federal Reserve were to take the total supply of dollars and double it — or cut it in half — the net effect on real prices for output would be zero. Whatever inflation the Federal Reserve were to generate in domestic prices would be offset by the decline in the exchange rate of its currency. So, to the extent certain commodities are priced both in dollars and, for example, euros, the ratio between the dollar price of the commodity and the euro price of the commodity will adjust appropriately.
There is, however, one important difference between the United States and Great Britain: although, US prices have indeed risen against world market prices, to the extent these world market prices are denominated in US dollars, no change can take place in the exchange rate of the dollar.
Instead, world prices are depreciated against all currencies other than the dollar, or, what is the same thing, the purchasing power of all other currencies appreciate. If you have been a close reader of this blog you will know that the appreciation of the purchasing power of money is an indicator that an economy is contracting — i.e., that the economy is falling into a depression. Here, however, rather than the appreciation of a national currency resulting from an economic contraction, the economic contraction is imposed on the economy by the increase in the purchasing power of its money.
How does this happen?
As in the case of Great Britain, there is nothing a country can do through its monetary policy to affect the new world prices which emerge once the Federal Reserve has successfully created an inflation of 2 percent. Should, for example, China attempt to devalue the yuan against the dollar to maintain its export surplus, it would find the domestic rate of inflation rising. Should it attempt to contain domestic inflation, it would find that the exchange rate of the yuan with the dollar is rising.
The loss of control over its own monetary policy is absolute — without warning, and quite suddenly, every other nation on the planet finds the Federal Reserve unilaterally dictating monetary policy for the entire global economy.
The failure of monetary and fiscal policy to stem deflation can be best understood by the economist’s simple-minded term, leakage. A leakage, in the economist’s lexicon of idiot phrases, is the unintended consequence of monetary or fiscal policy incurred when national economic policy has a bigger effect on the trade position of a country more than its actual target — the domestic economy.
Suppose, for example, the Bank of England wanted to maintain a rate of inflation of two percent a year. It would set its monetary policy to achieve this level of inflation, and the British government might boost spending as well to reinforce this policy by running a bigger deficit. If successful, prices will indeed rise by two percent, with no increase in output; or, if there is an increase in output, total prices will rise two percent faster than total output.
The British sheeple end up working more hours without seeing any improvement in their real material standard of living.
Now, suppose, as a result of this inflation, goods manufactured in China become increasingly competitive with those manufactured in Britain. British retailers could, by sourcing their product from China, further fluff up their profits beyond already obscene levels. Since, they are only interested in their profits and not employment, employment growth would shift to Chinese factories, while British employment would sag. With employment depressed in Britain, wages would begin to fall of a cliff, or, at least, fail to keep up with the cost of living. Ultimately, this begins to feedback into the demand for Chinese manufactured goods, leading to deflation.
Although the Bank of England and the British government intended to increase prices, the ultimate result of their activities is a deflation of prices.
But, it gets worse: the more the trade deficit with China widens over time, as each new round of easing takes place, the less effective the policy becomes, the larger the stimulus must be to be effective, and the shorter the period of time before it is overtaken by a further expansion of the trade deficit and deflation. Eventually, economic policy becomes altogether ineffective because its effects leak out more quickly than they can be implemented.
The approaching failure of economic policy, however, is celebrated by our simple-minded economist who will regard the declining rate of inflation as proof he has successfully solved the problem of managing a permanent low inflation economic expansion — which he fatuously names, The Great Moderation.
Then Federal Reserve Bank Governor Ben S. Bernanke was one of those simpletons who imagined that the increasingly obvious failure of monetary policy was, in fact, a sign of success:
The Great Moderation, the substantial decline in macroeconomic volatility over the past twenty years, is a striking economic development. Whether the dominant cause of the Great Moderation is structural change, improved monetary policy, or simply good luck is an important question about which no consensus has yet formed. I have argued today that improved monetary policy has likely made an important contribution not only to the reduced volatility of inflation (which is not particularly controversial) but to the reduced volatility of output as well. Moreover, because a change in the monetary policy regime has pervasive effects, I have suggested that some of the effects of improved monetary policies may have been misidentified as exogenous changes in economic structure or in the distribution of economic shocks. This conclusion on my part makes me optimistic for the future, because I am confident that monetary policymakers will not forget the lessons of the 1970s.
Forty-eight months later, with Bernanke now Chairman of the Federal Reserve Bank, the United States entered the greatest period of financial contraction it has experienced since the Great Depression. It was altogether fitting that our simple-minded economic theorists, who did not take into account that there was no longer any such thing as a national economy in the age of a globalized production process, should have celebrated their triumph at the very moment when their pet economic theories were in catastrophic failure!
Indeed this is just the picture we see in the graph below as the Federal Reserve drove the effective Federal Funds rate down to zero in a feverish struggle to keep the general price level from going negative.
A globalized production process is an idle dream unless there are also globalized prices for the output that production process creates. And globalized prices, if this term is to have any meaning at all, presupposes the loss of national economic policy. National economic policy tries to set national prices for output and ensure those prices, denominated in the national currency, rise at some determined rate each year; globalization, however, presupposes uniform production prices irrespective of the country of origin of the product or the national currency in which the good is denominated.
This may seem like a esoteric point, but it actually isn’t.
All you need understand is that the dollar is the most widely held reserve currency, constituting 62 percent of all exchange reserves held by countries and financial institutions. The Euro is the next largest reserve currency, constituting about 27 percent of the remaining reserves. The rest of the world combined make up the remaining 11 percent.
The great mass of liquid global social wealth is held in the form of dollars by central banks, corporations and financial institutions the world over; the vast majority of daily transactions between countries take the form of exchange of dollars for some product of labor; and the dollar is the most popular vehicle currency (currency of account) for exchange between various countries.
Essentially, for purposes of economic policy, the dollar price of a good is THE PRICE for that good; the global price of world GDP is denominated in dollars. The inflation targets of the European Central Bank, the Bank of England or the Bank of Japan is quite irrelevant. Under conditions of a globalized production process the only monetary policy that matters is that of the Federal Reserve Bank.
Whenever someone undertakes to explain “how quantitative easing works” the first question you should ponder is: how does this person define the term “works”. Remember, cyanide works, and so does aspirin — both will, for instance, cure a headache. How they work may, of course, have an impact on which you choose to treat a hangover.
To understand what is meant when we discuss how quantitative easing works (i.e., the meaning of the word works) we need to look at the role of the central bank.
In a propaganda pamphlet that would make even Orwell’s Ministry of Truth cringe, titled Quantitative Easing Explained, the anonymous flacks for the Bank of England explain the goal of quantitative easing this way:
Stable inflation promotes a healthy economy: Low and stable inflation is crucial to a thriving and prosperous economy. The Bank of England aims to keep inflation at the 2% target set by the Government. The Bank uses interest rates to control inflation. It sets an interest rate at which it lends to financial institutions – Bank Rate. That influences many other rates available to savers and borrowers, so movements in Bank Rate affect spending by companies and their customers and, over time, the rate of inflation. Changes in Bank Rate can take up to two years to have their full impact on inflation. So the Bank has to look ahead when deciding on the appropriate monetary policy. If inflation looks set to rise above target, then the Bank raises rates to slow spending and reduce inflation. Similarly, if inflation looks set to fall below 2%, it reduces Bank Rate to boost spending and inflation.
Supplying more money why it is needed: The money supply needs to keep growing at a steady rate to keep pace with the expansion of the economy, and to ensure inflation remains close to the Government’s 2% target. Money in a modern economy comprises both cash and bank deposits. Normally, the amount of money grows each year. In the past, there have been periods when money has expanded too rapidly. Too much money circulating in the economy eventually resulted in too much inflation. But if the economy weakens sharply, as it did in the final months of 2008, the problem is different. There is a risk of too little money circulating, not too much.
According to the Bank of England, the supply of currency has to be managed as the economy grows to ensure that the prices of goods rise each year by approximately the official target of 2 percent. When, as at present, the economy is severely contracting — not expanding — central bank intervention is required to keep prices from contracting as well. The primary function of the central bank, therefore, is not to keep inflation close to the official target, but to ensure that prices never fall.
However, in the present circumstances, conventional monetary policy tools have failed in this task; so the Bank of England is now trying to directly flood the economy with cash:
Same target a new tool: When the Bank is concerned about the risks of very low inflation, it cuts Bank Rate – that is, it reduces the price of central bank money. But interest rates cannot fall below zero. So if they are almost at zero, and there is still a significant risk of very low inflation, the Bank can increase the quantity of money – in other words, inject money directly into the economy. That process is sometimes known as ‘quantitative easing’. The Bank’s Monetary Policy Committee (MPC) meets each month to discuss economic developments and the outlook for inflation. At that meeting, the MPC votes on Bank Rate. It may also decide whether to inject money directly into the economy, and if so, how much.
So we can define the word “works” to mean that quantitative easing, if it is effective, will force you to pay more for everything you purchase. Or, to put it another way, if quantitative easing is successful, your present income will no longer be sufficient to support your material standard of living — you will be 2 percent poorer each year that Washington can achieve its target rate of 2 percent inflation.
In other words, to say quantitative easing works is actually to say YOU WILL WORK — and you work longer and harder each year, just to maintain the same standard of living. Which should be no surprise to you, since only Wall Street Bankers assume We, the Sheeple of the United States, are so dumb as to not notice that higher prices mean we must work more hours or be paid more for the hours we already work in order to buy the same amount of goods.
At the same time, successful quantitative easing implies that these increasing hours of work, and even higher pay for a given amount of work, must not result in more real goods per hour of work. The additional hours of work put in by the population must consume more of the existing output of society than it adds to it, otherwise there is no inflation.
If, for example, the productiveness of the society should increase by 4 percent in a year, the amount of work actually performed must increase by 4 percent + 2 percent or 6 percent each year to achieve the target inflation rate of 2 percent set by the central bank.
The very idea that a central bank (the big ones are the Federal Reserve Bank, the Bank of England, the European Central Bank and the Bank of Japan) would have as its mandate to actually make society less productive, to make work less productive, is so astonishingly bizarre and conflicts so radically with common sense that few people even appear to notice it. The term productivity holds such an honored position in the national economic myth, it appears patently absurd to think reducing productivity is Washington’s actual goal. Only occasionally do we get a glimpse of its effect on hours of work as seen in this snippet from Bloomberg Business Week:
If there was little surprise in much of the speech, however, [former Obama Economic Policy guru Larry] Summers did offer up one new insight into why unemployment keeps going up so sharply despite the stimulus spending. He argued that productivity has remained stronger at this point in the recession than it has in similar downturns in the past, meaning employers can get by with even fewer workers than might otherwise have been expected. Summers added that the phenomenon is not well understood. Here’s his take:
“The economic contraction has caused significant job loss. It is noteworthy, however, that the higher than forecasted job losses do not appear to be primarily the result of weaker-than- expected GDP. Rather, it appears that a given level of output is being produced with fewer people working than historical relationships would have led one to predict. In economists’ language, there is a significant residual in the Okun’s law relationship: the unemployment rate over the recession has risen about 1-to-1.5 percentage points more than would normally be attributable to the contraction in GDP.
To put the point a different way, normally in economic downturns, productivity decreases as firms keep workers employed even as the amount of work declines. This pattern of deteriorating productivity has not been a feature of the current recession. In fact, productivity has increased in this recession, as it did in the last.
One potential explanation for this phenomenon, though by no means a dispositive one, is that the greater financial pressure on firms in this recession has led them to shed cash flow commitments at an unusually rapid rate by laying off workers and leaving jobs vacant. Perhaps an expectation that the recession would be lengthy has also contributed to this behavior.”
While we — the great unwashed — may think of productivity as a measure of real output per hour of work — how much can be produce in so many man-hours of work — this is not at all how companies measure it. To put it simply, a company measures its productivity by the amount of profit it can produce with a given amount of wage.
Thus, in another article we find:
Of course, there’s the dark side to productivity. Efficient and flexible companies are more likely to shed employees quickly in response to a falloff in demand — real or expected — than they would have been in the 1970s and 1980s when they tended to hoard labor in hopes of an eventual recovery.
“Nowadays, (companies) seem to anticipate a decline in output and lay off workers ahead of time,” said Brookings Institution productivity expert Barry Bosworth.
That may keep productivity high, but with a far different human toll than output-driven productivity of the kind seen in the late 1990s when improvements in information technology led to entire new industries and employment opportunities. Employment grew then, just not as fast as output. The reverse is happening now: the economy is contracting, just not as fast as employment.
It is a common mistake to confuse these two different measures of productivity, but they are not the same and have no relation to each other. Since companies operate to maximize profits, they continually try to squeeze more output from the existing work force. In times of expansion, they hold the rate of growth of their work force to below the rate of growth of demand for their output; and, in times of contraction, they try to reduce the work force more rapidly than the demand for output contracts.
During a contraction, however, and under certain definite conditions, this impulse can lead to an economic death spiral as companies continually eviscerate their work force to shore up profits. When the demand from this work force is the most important source of demand for the goods produced, slashing the work force must result in the progressive collapse of demand for the output itself.
The evidence of this collapsing demand would be generally falling prices — the much dreaded deflation of the economy. Inflation slows, and then stops altogether and reverses, as falling prices invade one after another sector of the economy. Soon, the economy as a whole is engulfed in raging deflation as companies frantically slash the work forces ahead of the drop in demand created by the previous round of layoffs.
The deflation, of course, only signals that profit can no longer be the motive force for the production of goods. But, for capital this amounts to a death sentence, since the motive for capitalist activity is profit.
By the time quantitative easing becomes necessary this death spiral is already approaching like the Mother of All Storms on the horizon. Monetary and fiscal policy have already broken down, and things have truly progressed beyond the point when just any central bank can reverse the process. Policy tools have collapsed because the deflation threat is no longer a national problem but a global one for which there is no national solution.
If the deflation can be avoided, there is only one central bank capable of the scale of intervention necessary to prevent it. It is capable of intervening not because it is a national central bank, but because it already functions as the global central bank: The Federal Reserve, because it controls the world reserve currency, and can, as a consequence, impose inflation not just on the sheeple of the United States, but also on the populations of every country engaged in international trade.
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.