QE: Because Nobody’s Got Any Better Ideas

29 May

Flowchart

QE: What you’d call a bit of a controversial policy. Asset prices have shot up recovering pre-crisis highs. Meanwhile the real economy – especially those bits that affect the poor and the young – remain deep in a pit of despair. I don’t agree with Frances Coppola on this, but she’s got some good posts accusing QE of making things worse , especially in the UK. (there’s also this excellent subsite for discussion on the topic). And of course we have the insistence – from the reasonable to the reliably demented that this is all a bubble and that the next hard landing will be worse.

But I come not to bury QE, but to praise it. Or at least point out that it’s probably better than doing nothing, and that “nothing” seems to be a pretty good description of the other politically-acceptable alternatives globally.

First, let’s deal with the “QE distorts prices and changes the behaviour of investors”. This is like complaining that “cars carry people to different places”. It’s not an objection, it’s a description of the WHOLE DAMN POINT of the exercise. A case in point: the recovery of the housing market has been driven by investor demand. And it’s the big institutions – the WSJ link points to 20,000 homes snapped up by Blackstone. This is what happens when the search for income, driven out of Treasuries by low yields turns into activity. This is FoBOR at work (Forced Buyers Of Risk to use Dan Davies‘ term)

High maintenance costs traditionally had kept investors out of managing hundreds of scattered-site rentals. But investors set about overcoming those hurdles two years ago because low interest rates engineered by the Federal Reserve generated “a tremendous appetite for yield,” said real-estate consultant John Burns, who advises investor firms. “It really sent capital chasing to figure out this business.”

and Bloomberg on the same story

The firm, along with Thomas Barrack’s Colony Capital LLC and Two Harbors Investment Corp. (SBY), is seeking to transform a market dominated by small investors into a new institutional asset class that JPMorgan Chase & Co. (JPM) estimates could be worth as much as $1.5 trillion.

This is QE working as planned. Reduce the returns on assets like bonds to the point where other activities become interesting to investors. The payoff for the real economy is the considerable money investing in renovating the properties and mobilising the building sector (US homebuilding is the global economy’s Great Hope) by resuscitating demand.

Now, this is definitely a pretty roundabout way of driving money into the real economy. Instead of putting the money directly to work, pay money to people who already have assets even more than their assets are currently trading for, in the hope that they’ll put at least some of the money to work. It’s unkind but not entirely unfair to compare it to trying to persuade a fat man to take some exercise by massively overpaying him for his car. It can work. But it might also put him in the market to pay huge sums for any old piece of crap car in the hope that you’ll overpay for that one too.

Money has to be not just provided by the central bank, it has to be spent. The money can be spent directly by government (Keynesian style); plan B is Chinese-style directed lending. This isn’t the place to rehearse the debates about this, though I personally am very very suspicious of plan B. A “banking system responsive to local needs” quickly becomes “a piggy bank for local politicians” (see Spanish cajas). Everybody has their own view on this – but I’ll confine myself to the deliberately narrow “If Plans A and B are off the table, does QE do more good than harm?”

(Side note: QE is not Plan C “helicopter money” – which in practice might consist of crediting all bank accounts in the country. QE involves paying over a $ (or £, or Yen) amount in return for an existing asset. This is a crucial feature, and accounts for many of the drawbacks – in particular that the policy benefits above all existing holders of assets. In theory, just handing money to everybody in the country is a more effective and equal way of acheiving its aims. But you don’t have to be a hard-money Bundesbanker to be at least a little uncomfortable with where this might end up).

Politics suddenly looks pretty primary here: fiscal stimulation and liquidating the banks are apparently off the table, to the symmetrical disgust of Keynesians and Austrians. It’s easy for those close to the financial system to lose sight of this, and fail to ask the big question of why. So mysteriously we’re left with the only stimulus route which as a design feature favours those who already own assets, and even more those who own those assets via leverage. But can we at least recognise that fiscal expansions, directed lending and money printing are revolutionary and experimental and have massive drawbacks of their own. The same goes for “letting the banks take the pain”, as Cypriots can testify.

There’s plenty to object to about QE. Can it cause bubbles? yes. (though I for one am pretty adamant it hasn’t so far) Does it disproportionately benefit the wealthy over those on fixed incomes? Yes. As long as the banks are dysfunctional and reluctant to lend without collateral, this effect will be reinforced. This may well be why the UK variant of QE has been so unsuccessful compared with the US variety.  But, absent a revolutionary political change, QE (and its lesser cousins, OMT and LTRO)  are the only game in town. I’ll lament the political gridlock that has left a dysfunctional and (outside the US at least) partially zombified financial system in place. But given a choice between zombies with and without QE, I beleive evidence strongly supports the former.

22 Responses to “QE: Because Nobody’s Got Any Better Ideas”

  1. Frances Coppola May 29, 2013 at 9:24 am #

    I totally agree with the title. Given absolute horror of any form of direct reflation, and prevalent belief that fiscal policy is either useless or destructive, no-one’s got any better ideas, so they do more and more QE in the hope that it will somehow work. That does not mean that it will achieve what they want. Irrational fear is the worst possible reason for continuing with an ineffective policy. If direct reflation and/or fiscal expansion are appropriate tools they should be used.

    I agree that the financial distortions are due to QE doing its job. It is the untoward effects of QE doing its job that are the problem.

  2. SK May 29, 2013 at 11:09 am #

    Pawel,
    The post/diagram are spot on but you have to probably take into account the long term impact from QE before you decide if QE is worth it.

    1. Compound effect on savings is lost which will mean that savings will not deliver the required income in the future and therefore a higher percentage of pensioners will be dependent from the state.
    2. Low Annuities which are having an impact on pensioners now.
    3. High Asset prices (see houses) will make current 20s/30s generations to rent for even with no ability to save (high rents/inflation and low savings) and therefore no asset to help them when they grow older
    4. Lack of growth due to the zombie effect. The Market mechanism cannot operate so efficiency is not rewarded
    5. Moral/Fairness. How is it moral to punish the prudent in order to save the reckless?

    The impact of the above will increase as the QE policy continues or it is not reversed.

    • cas127 July 4, 2013 at 7:25 am #

      “How is it moral to punish the prudent in order to save the reckless?”

      Heh.

      Forget *moral* – think *wise*…ten years of more or less ZIRP have made the Fed the mortal enemy of the saving class in the United States.

      The second a viable alternative appears (the *second*) that savings class will abandon the dollar and the current US political structure will collapse.

      (American politicians have prostituted their inheritance and turned the country into Argentina)

      The US political “elite” has turned the domestic economy into a crack whore for easy credit, backstopped only by a dying international reserve currency.

      Once that reserve status is lost (and it is going, going, gone) try selling soybeans and Nancy Pelosi’s smile (Senator Rictus) for the oil imports that the US needs to function.

  3. Ben May 29, 2013 at 3:46 pm #

    Your discussion around the banking system is 5 years old and largely irrelevant in the U.S. at least. The banks are extremely well capitalized now and are not in need of support. “Dysfunction” of not wanting to lend to people who can’t pay you back is not dysfunction but rationality. The idea that asset inflation not driven by fundamentals will lead to good things does not resonate with me at all. Eventually the asset inflation will turn once the “juice” is withdrawn, which will lead to everyone being worse off once again. Yes, it has helped drive the price of homes up – but why do we really want to favor the real estate market, which provides little in the form of “good economic growth?” Let’s make housing less affordable for people once again – great idea! The kind of economic growth that improves people’s lives is productivity enhancing R&D and productive capital investment. There doesn’t seem to be any evidence that QE drives this behavior.

  4. KevinM May 29, 2013 at 4:36 pm #

    Is it possible to believe in QE and disbelieve trickle down economics?
    Idea sounds similar, give rich people money and hope they share it with less-rich people.

    Yeah, the title to this post is spot on. I certainly don’t have any better ideas.I’m just paying bills and hoping not to get inflated or deflated out of existence.

  5. Ralph Musgrave May 29, 2013 at 4:50 pm #

    “But you don’t have to be a hard-money Bundesbanker to be at least a little uncomfortable with where this might end up.”

    The suggestion presumably being that excess inflation might ensue. Well if inflation stems from stimulus done via helicopter drops or via fiscal policy, then pretty much the same inflation will result from doing stimulus via QE. So that’s not an argument against helicopter drops or fiscal policy.

  6. Groda May 29, 2013 at 6:41 pm #

    ” just handing money to everybody in the country is a more effective and equal way of acheiving its aims.”

    This certainly seems likea better idea to me. It’s strange that it isn’t even seriously discussed.

  7. Joe Keller May 29, 2013 at 7:00 pm #

    As far as QE is concerned, it is the best choice we have on the table. The cure for higher prices isn’t higher prices. While QE is deleverages toxic assets on banks books, it will hurt those on a fixed income as well as those who save. With that said, I believe we are seeing real economic growth in the economy albeit the looming uncertainty.

  8. Kos May 29, 2013 at 9:48 pm #

    Absolutely awesome. Loved this and trickle down economics was just about as accurate as “limited oil supply”. A farce and just another method for wealth redistribution. If you’d ever consider doing a guest post, we’d love to have you @ http://stockbuz.net

  9. Chris Cook May 29, 2013 at 10:07 pm #

    I’m surprised you’re adamant there have been no QE induced bubbles.

    My take is that a legion of ‘muppets’ – passive investors aiming to avoid loss rather than make a speculative transaction profit – were mis-sold market risk by investment banks marketing ETFs, ETPs, structured products etc using the ‘inflation hedging’ marketing meme.

    We saw correlated bubbles across gold, energy stocks and commodities where every twitch in the $ yield curve saw corresponding twitches in the forward price curves of these thoroughly financialised markets.

    What has now changed is that it has been belatedly recognised that when 99% of people are illiquid, insolvent or both then the purchasing power to cause inflation is simply not out there, and indeed, barking mad austerianism is making a bad situation worse. ie applying leeches to a patient bleeding internally.

    Bottom line is that the former inflation hedging money is now departing gold and other ETFs and is in search of yield – any yield.

    Buy-to-let property and mature stocks are the best place to find that.

  10. Dexter Bland May 30, 2013 at 1:18 pm #

    I suspect the end result of institutional investment in the housing market will be lower rates of home ownership, and higher rents. Another tax on ordinary consumers levied by the financial sector, leading to greater wealth inequality and lower aggregate consumption.

  11. JVM June 3, 2013 at 6:15 am #

    Isn’t the better idea NGDPLT? Or even price level targeting? I suppose you could argue that QE would be the mechanism for this, but it seems like the statement of the actual target policy would solve all the issues arising from uncertainty, etc. which are probably a pretty big deal, plus promising level targeting is equivalent to a promise not to make bubbles (you’re promising there won’t be any surprising rise or surprising fall).

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