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The Political Economy of Quantitative Easing

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asymptotix bataviaWhy a Monetary Stimulus was Insufficient this time around

It's a well worn phrase but a profound idea that no matter how clever or high performance your forecasting system; you never see a turning point in an economic time series until it's behind you.

THE PAST AS A MODEL OF THE PRESENT AND FUTURE

Seeing the turning point behind you clearly is fundamental to understanding what's going to happen next. Niall[1] Ferguson's perspective is that one cannot understand current and future economic systems and their potential behaviour unless one understands how similar historic 'configurations' behaved in the past. You need to know the flow of history well enough to be able to locate a set of events in the past which can serve as blueprint for what is happening now. So that when you see a turning point some months behind, you can compare how the curve moved forward in the comparative period which you select. Thus you have a benchmark in the past to predict events from the here and now; such a methodology pertains so long as general similarities in basic conditions can be assumed to exist in the past and the now; what is referred in the dismal science as "ceteris paribus"[2]. But you need to select the appropriately analogous time period so that if the c-p assumption holds then events should unfold from the present on a trajectory similar to that which they observed in the past. I tried to use this technique recently to discuss how the Monetary Stimulus policies of the US, UK and Europe might unfold in a discussion paper called Quantitative Easing and the Yield on the Ten Year Gilt: As we have seen in the first half of 2011, things didn't quite work out that way and this paper is an attempt to explain why not.

CONSTERNATION: FAILURE OF QE

Recently the Great Depression has been compared to what is happening now, the work out of the Great Financial Crash of 2007[3] (#gfc07, if you prefer) and if you believe that period is sufficiently similar then Ben Bernanke being the world's foremost expert on that period[4] is the right man to be running the Federal Reserve. But as you all know it's all about discrimination of the similarity and thus it's the differences between the comparative period and the current which allow you to first explain and then possibly forecast what is going to happen next; this time around.

The Federal Reserve is causing consternation to practitioners in US capital markets right now. It doesn't do that very often; it's the ECB which is expert at confusing commentators and investors. The indecision from the Fed over whether another round of QE[5] will be expedited is the cause of consternation. Indeed it may be the case that what we get in the US (more out of desperation than rationality) is QE by stealth; accommodative QE in the US; simply because pulling on any kind of fiscal lever is just politically impossible right now; i.e. QE & variants of it are the only show in town. Europe is in a similar place but QE has halted there, the issues around the independence of the Central Bank being crucial to that decision; QE has ceased in the UK, simply because the British government has run out of cash & an illiquid Bank of England looks not impossible in the medium term. George Osborne is the Prince of the Right Wing globally since his policy is to expedite the desperate measure of Fiscal Austerity on the basis that abandoning the bulk of the UK population to an unsupported jungle will engender the animal spirits of the invisible hand and thus "magic up" some voodoo of economic activity driven by desperation. Riots on the streets are more likely, fencing off Stoke on Trent the more plausible scenario, if you ask me!

The consternation at the Fed is because all the dashboard data is telling them that the spillover effect to the general economy (employment, consumption) from their inflation of capital markets (Monetary Stimulus or QE) is just not happening. So the capital markets are ballooning and there is nowhere for that latent monetary gas to go but massive inflation down the road. I guess the Clark Kents in the Fed are asking themselves "what did I miss?"

QE IS EXCEPTIONAL MEASURES

asymptotix msPolicy makers know that clear strategic direction to investors in bond markets is crucial to management of Money Supply in particular so that expectations don't get out of alignment effecting wild swings in key capital markets variables. We are in unusual times, Trichet uses the phrase; 'Exceptional Measures' and is clearly personally irritated that his EM have not worked. The failure of EM in Europe is clearly indicated by Trichet turning head-masterly to peripheral governments and chiding them to get their act together, while his institution (which he departs with relief shortly) teeters on the brink of implosion under a pile of junk debt.

QE is not simple; there are in fact two distinct types of QE (or Monetary Stimulus); they can be thought of as characterise-able as Voluntary and Involuntary. The Reaction Function of the Central Authorities (including the Central Bank) can be thought of as a balancing mechanism in the first instance which kicks in when the dumb brute force of the invisible hand starts to drive the economy into a depression; in essence the herd instinct drives markets on to a bid basis. The involuntary aspect of Monetary Stimulus then makes itself available to generate an expectational floor for markets which as the theory goes; they then slowly bounce off. The voluntary aspect of QE commences when the involuntary reaction doesn't work, the voluntary bit is what Trichet calls "exceptional measures" i.e. open market operations by arms of the central authorities to purchase Capital Market assets again essentially to move assets off a bid basis and onto an offer basis. The idea is that private sector entities will catch the expectational wind of the offer-push and drive wealth effects and employment decisions through that impact. (This is what I over-simplify as the spillover channel of the impact of Monetary Stimulus).

At this crucial time the fiscal and monetary authorities are out of ammunition. They have taken their best shot, and it hasn't really worked although they did prevent a collapse of the global financial system; at least so far. The major problem with the economy is that consumers are not spending as a result of the record household debt built up over the last few decades. Until this huge amount of debt is pared down to more normal levels, fiscal and monetary policy can do little to return the economy to previous growth rates. But there is another crucial difference in the environmental configuration today and that which pertained the last time "Monetary Stimulus" (QE) was expedited in the 1980s to shock the economic system out of a depressive liquidity trap. This key difference has been conveniently overlooked in the over reliance on Monetary tool sets as a consequence of Fiscal stimuli being regarded as simply politically heretic. This key difference is politico-economic, socio economic; in the 1980s the Thatcher and Reagan governments liberalised access to capital markets for the ordinary Joe in the street, main-street; the Clapham omnibus, they fired him up with 401k's and opportunities to purchase equity in privatisation. These socio economic changes reinforced or indeed facilitated the process of wealth spillover which is the objective of monetary stimulus; quite the reverse is occurring today since in a 401k or indeed in a UK mutual fund, even the most conservative Bond funds are getting battered to death! Not good for the interface between main street and Wall Street and certainly destructive of the very channel which QE needs to be efficacious.

If QE had worked the rising tide would have floated all the boats and the peripherals'; horror stories would not be visible and we could all go back to muddling through on the basis of figures which are fantastic. The irony is that this time around QE turned out to be much more than just a monetary tool. QE was, arguably, a trigger towards a global political shock therapy instead of a domestic economic stimulus, a road to revolution for those living under more authoritative regimes in the world. The premise of the "Arab Spring"; whilst unemployment continues to rise in the western domestic economies. Lets face it the guys at the helm of the western central authorities DID NOT HAVE A CLUE! They continue to behave (particularly in Europe) like clueless idiots by wrecking global fixed income market liquidity and price discovery, particularly by lack of attention and indecision which in my view can only be a product of a fundamental lack of understanding of how economics of any shape or form actually functions. It's the un-dismissible ones I despise causing havoc in their own back yards; Van Rompuy the Belgian and Barrosso the Portuguese - gentleman you don't have a clue!

QE (it's an awful term) is a monetarist twist on a Keynesian idea that it is the duty of the Central Authorities to deploy what is essentially Government Capital to rectify the economic machine when it breaks down. Keynes advocated using Fiscal approaches which means the government builds rail lines or bridges (what is termed "spade and shovel" sometimes) but that has been rejected in the late 20th Century because the consequence of that is the Government ends up owning the economy and thus laissez faire efficiency and the invisible hand cannot function. There are a number of ways through which injections of money into the economy via asset purchases funded by reserves (QE) might be expected to affect nominal spending growth. But one important route is through higher asset prices, which should reduce the cost of obtaining funding and increase the wealth of asset holders, thus boosting spending and increasing nominal demand (the spillover - capital markets get fat first)!

THE POLITICAL ECONOMY OF QE

The social democratic perspective on political economy is that the 'economy' is best left to the people and the government should be minimal but the government should retain the capacity to right the powerful machine if it gets too hot or too cold. Thus the QE approach which is to effectively avalanche money through the capital markets with the objective of adjusting yield expectations and in that way inspiring investment by the private sector. Keynes Fiscal approach was the policy response by Roosevelt to the Great Depression. Whether it actually worked or not cannot be scientifically validated since the US Economy became a "Command Economy" in the run-up to WW2.

Claims are often made that there are examples where fiscal austerity has worked. But it turns out that this is generally due to the monetary stimulus that accompanied it, as in Britain under Margaret Thatcher in the 1980s. There is, however, one important difference between the situations now and then in that the flow of finance to support the growth of private sector businesses has been affected by the impact of the financial crisis on the banking sector. For many businesses and individuals, the terms on which they can access lending are much less favourable than before the crisis. Moreover the flat-lining of capital markets entails that savings schemes of all sorts have not grown to meet their future liabilities, thus the pensions issue in the western democracies, further alienating the man in the street from the financial system. Add to that the scandal stories of the squid (Goldman Sachs) and the continued payments of huge bonuses to the senior executives of bailed out banks; the ordinary man in the street is not only progressively disengaging from financial markets and products, he is becoming daily more alienated from the whole process. This is the reverse of the socio economic expectational reinforcement of monetary stimulus expedited by the governments in power the last time QE was tried. It's very much different today.

asymptotix piccadillyThe Political Economy of all of this is first premised on the basis that as a result of fear and greed; the herd instinct of expectations, the market monster fails sometimes; either drives itself into massive black dog depressions or can become manic in the creation of irrational exuberance causing asset bubbles. This is inherent in the human psyche, Google quoted Nietzsche recently: "Madness is something rare in individuals - but in groups, parties, peoples, ages it is the rule."  Gordon Brown just didn't get it in his Golden Age nonsense at the Mansion House. The role of the Central Authorities is almost to involuntarily intervene if either of the mania or the depression circumstances occur. Of course we know that for a while Governments like exuberance, everybody wandering around on some variant of laughing gas, throwing cash around like a Piccadilly Highlander, that works; vote for me & the tax take goes up. We have learned about that this time we have got new early warning committees in the UK and Europe now, so that will never happen again, oh well .... But its when it all hits the floor, when the banking system goes onto a bid basis, starts pulling the working capital support from the retail industry, the banks need to shore up their balance sheets right? Particularly if they cannot be supported by x-funded profits from their casino divisions, oh yes they aren't making any. That's when the answer is Monetary Stimulus, eventually a crumb will spillover to Buchanan Street or Blythswood Square; that's the theory but there are problems, an example of which I detailed recently: http://www.asymptotix.eu/crowding-out-2

Right wing governments resort to privatisation in order to diffuse "popular capitalism", achieving the political objective of increasing the support for market oriented platforms. BT was sold to the public through an initial public offering, partly to create widespread public share ownership. Posterity must question precisely what was achieved by the sales of British Telecom, British Gas, British Petroleum, British Steel and the rest, apart from raising vital billions for Tory Government coffers and bribing voters with apparently easy investment gains. Thatcher's was no single-handed effort. In changing business, and its reputation, she was in the vanguard of an international trend towards liberalised, decentralised, business-friendly campaigns to restore faith in commerce and create wealth. Total holdings of equities by U.S. households rose from 17.2 percent of household financial assets in 1980 to 34.9 percent in 1998, the highest percentage of total household assets in the post-World War II era; all driven by US government policies of facilitation, liberalisation and promulgation of the message that capital markets were good for your wealth; that is not an option today in fact for the reasons I have referred the engagement of the populace with risk capital and even fixed income instruments is travelling now in the opposite direction. Let us be clear if the ordinary populace continues to disengage with capital markets in the manner being currently observed then flat-lining equity indices is only the naïve result; the management of "Surplus Value" will transfer to the central authorities (yes, those unelected idiots I so despise) and the objective of Karl Marx will have been achieved by accident; that is the logical extension of this analysis. The shift (in the 80s and 90s in the US) from employer-directed, defined benefit pension plans to self-directed, defined-contribution plans; most of which include equity investment options; introduced asymptotix marxmany U.S. workers to individual stock and stock mutual funds. As of 1997, 66 percent of U.S. workers participated in retirement programs that offer tax-deferred accounts. Also in that year, nearly all (97 percent) 401(k) plans offered equity investments. In the 80s and 90s central authorities in the western democratic nations shifted the management of Surplus Value back to the individual in mutual groups effectively and left the growth of society's surplus value to the capital markets. Now, with the wreckage of capital markets and the banking system behind us, the idiots in charge of policy are driving the management of surplus value back towards themselves and I don't even think that they know they are doing it.

CONCLUSION

This socio-politico-economic problem is much bigger today and I think it's the reason that any form of Monetary Stimulus just will not work today. The Capital Markets have alienated Main Street. That is the position today which fundamentally differs from the position 10/15 years ago when monetary stimuli did have the desired effect in the requisite timescale. Then the monetary stimuli were reinforced because the governments incentivised and marketed participation and engagement with capital markets to the man in the street. A one-off social change which reinforced the channel of monetary stimulus, that kind of social engineering is not possible after the great financial collapse. It's that contextual difference which one has to discriminate as being different now from what it was like then. That is why QE will never work now, could never work. Roubini's perfect storm of 2013[6] could be on! We cannot repeat the increased engagement of the man in the street with capital markets and financial products; the #GFC07 has done for that for a generation or three at least[7].

 

 

 

 


[1] http://www.niallferguson.com/site/FERG/Templates/Home.aspx?pageid=1

 

[2] http://en.wikipedia.org/wiki/Ceteris_paribus

 

[3] http://www.asymptotix.eu/content/anniversary-lehman-collapse-wrong-anniversary

 

[4] http://www.asymptotix.eu/content/ben-s-bernanke-monetary-policy-objectives-and-tools-low-inflation-environment-full-speech-15

 

[5] http://www.asymptotix.eu/define-quantitative-easing

 

[6] http://www.economonitor.com/nouriel/2011/06/13/bloomberg-%E2%80%98perfect-storm%E2%80%99-may-threaten-global-economy-roubini/

 

[7] http://www.asymptotix.eu/content/financial-crisis-2015-avoidable-history

 

REFERENCES

 

http://dallasfed.org/research/eclett/2010/el1003.html

 

http://www.equitynews.info/2011/06/21/robert-auerbach-does-the-stimulus-stimulate/

 

http://www.wiwi.uni-muenster.de/06/nd/fileadmin/vfs/2011/Schnabl.pdf

 

http://www.bankofengland.co.uk/publications/speeches/2010/speech452.pdf

 

http://www.cass.city.ac.uk/__data/assets/pdf_file/0020/81344/Oracle_-_July_24th_2009.pdf

 

http://www.fxstreet.com/fundamental/analysis-reports/market-comment/2011/06/10/

 

http://host.madison.com/ct/news/opinion/column/article_33978541-4aaa-5737-8ced-69d1a906dc41.html

 

http://www.richmondfed.org/publications/research/economic_review/1986/pdf/er720202.pdf

 

http://www.brookings.edu/~/media/files/rc/papers/2008/0110_fiscal_stimulus_elmendorf_furman/0110_fiscal_stimulus_elmendorf_furman.pdf

 

http://www.stanford.edu/~johntayl/Taylor%20Williams%20Policy%20Rules%2010-5%20930am.pdf

 

http://www.thefreemanonline.org/featured/subprime-monetary-policy/

 

http://ftalphaville.ft.com/blog/2011/03/08/507446/qe-as-shock-therapy/

 

http://www.ft.com/intl/cms/s/0/76e1c49c-9d1c-11e0-997d-00144feabdc0.html#axzz1R7Yq4CTR

 

http://research.stlouisfed.org/conferences/qe/wp393.pdf

 

http://www.ridgway.co.nz/files/energy-reform-history.pdf

 

http://www.timesonline.co.uk/tol/news/politics/thatcher/article6215236.ece

 

http://www.feem.it/userfiles/attach/Publication/NDL2001/NDL2001-077.pdf

 

http://www.organizzazione.unina.it/cms7/proceedings/proceedings_stream_24/Klimecki.pdf

 

http://www.ici.org/pdf/rpt_equity_owners.pdf

 

http://webuser.bus.umich.edu/gfdavis/Papers/Davis_Cotton_stockholding_Republicans.pdf


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