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The Fed appears poised to resume quantitative easing both because legitimate fears of deflation have resufaced and because the strategy incidentally benefits stock and bond investors, seen as preferable to fiscal stimulus which boosts employment but adds to the national debt. As Barron's correspondent Jonathan Laing notes below, "a rally in bond prices induced by quantitative easing eventually translates into higher stock prices…it seems plausible that both the economy and stock market might have faltered in recent months as a result of the suspension of the quantitative-easing program on March 31..." On the other hand, "more fiscal stimulus is politically out of the question", Laing reports, repeating the canard that direct spending on job-creating infrastructure and other government programs "doesn't seem to be working", and contradicting the recent CBO and Blinder-Zandi studies suggesting that even the Obama administration's inadequate spending helped stave off a depression. In any event, concludes Barron's: "It's high time to get out the money-printing machines. Damn the risks of triggering a bit of inflation and some modest investment bubbles. The alternatives are far worse." - MG * * * Time to Print, Print, Print By JONATHAN R. LAING Barron's August 7, 2010 FED CHAIRMAN BEN BERNANKE'S recent testimony before Congress was fairly pallid. He described the current economic outlook for the U.S. as "unusually uncertain." (When isn't it?) Growth in gross domestic product seems to be flagging some, but Bernanke implied the Federal Reserve wouldn't be reaching into its bag of monetary tools unless the economy were to double dip into recession or financial markets turn unruly again as in 2008. That's a mistake. The Fed should, and probably will change its tune by the fall and fire up the printing presses. Its current stance of watchful waiting in the face of slowing economic growth, inflation cycling below its preferred target rate of 1.7% to 2% and naggingly elevated unemployment strikes some observers as nothing short of mind-boggling. With good reason, these critics are pushing the Fed to adopt the deflation-fighting strategy that Bernanke mentioned in 2002, when he was a newly minted Fed governor. He suggested that the Fed could always buy long-term government bonds and corporate debt to mainline more liquidity into the financial system to counteract incipient deflation. This approach has come to be known in financial circles as "quantitative easing," though the tactic rarely has been employed. The Bank of Japan tried it with mixed success early in this decade, and it became a centerpiece of both U.K. and U.S. monetary policies during the 2008-2009 financial meltdown. Indeed, the Fed from early 2009 to the program's conclusion on March 31, 2010, bought some $1.3 trillion of Treasury bonds, Fannie Mae and Freddie Mac mortgage-backed securities and agency debt with dollars essentially created out of nothing. Typically, central banks use their control of short-term interest rates to influence money supply, control inflation and hopefully fine-tune the pace of economic activity. But that traditional weapon has been taken out of many central banks' hands with short-term rates effectively standing at zero in Japan for the past 15 years and in the U.S. for the past year and a half. Thus the Bank of Japan and now the Fed buy longer-duration paper to push funds into the economy. Positive interest rates on the paper provide some room to maneuver. The intent of quantitative easing is manifold. By effectively printing money and buying securities, the Fed hopes to create excess reserves in the banking system and induce more lending and therefore output growth. At a minimum, the tactic lowers long-term borrowing costs. making it more attractive for companies to add to capacity and for consumers to spend more, particularly on big-ticket items like cars and homes. In fact, some recent studies show that drops in long-term rates have three times the potency on GDP growth as comparable drops in short-term rates. Finally, quantitative easing is intended to act as an adrenaline shot to confidence and what Keynesians, advocates of fiscal stimulus, like to call the animal spirits. The fact is that all markets are linked across the risk spectrum. So a rally in bond prices induced by quantitative easing eventually translates into higher stock prices and sprightlier GDP growth. It seems plausible that both the economy and stock market might have faltered in recent months as a result of the suspension of the quantitative-easing program on March 31 as much as from the onset of the European credit crisis. As a consequence, pressure is building mightily on Bernanke and the Fed to launch another money-printing operation and buy more securities. It's about the only thing they can do in today's "zero bound" fed-funds rate environment. Action on this front could come as early as the Fed meeting in September, when three new governors, all presumed inflation doves, will be on board. Certainly, more fiscal stimulus is politically out of the question, given the financial Calvinism that has swept through the U.S. in the wake of Europe's sovereign-debt problems. Yawning budget deficits as far as the eye can see have become anathema to the electorate. And the theoretical multiplier effect that deficit spending is supposed to deliver—excess economic growth for every dollar the government spends—doesn't seem to be working. The slack in manufacturing capacity and employment has barely budged. Corporations and consumers are keeping a tight grip on their cash—rather than spending freely ahead of an expected rise in their tax burden, brought on by the national debt. Quantitative easing doesn't add to the national debt. The assets purchased just sit harmlessly on the Fed balance sheet until they mature or are liquidated. Promiscuous growth in the money supply, of course, can both fan inflation and debase the currency. But inflation hardly seems a concern these days—just economic growth. Moreover, quantitative easing would fill a void in the financial markets as it did after the securitization markets died an ugly death during the 2007-2008 financial crisis. Besides, any measure that would help the economy reach escape velocity from its current unsatisfactory orbit would likely be appreciated by both U.S. creditors and the citizenry. Signs of a sea change in attitudes toward quantitative easing are growing, even in unusual quarters. Last month, the European Central Bank quietly invited Vincent Reinhart, a powerful figure in the Greenspan Fed as director of the Division of Monetary Affairs from 2001 to 2007, to conduct a seminar on quantitative easing for its top staffers. That was momentous, given the institution's history as a bastion of monetary conservatism and rectitude. "I don't know what ECB's plans are, but it should be pointed out that they have all the instrumentalities already in place to launch an aggressive program of quantitative easing," Reinhart tells Barron's. Alan Blinder, Princeton economist and former vice chairman of the Fed under Bill Clinton, admits to a personal preference for fiscal stimulus. Yet a recently released study by Blinder and Mark Zandi, chief economist of Moody's Analytics, concedes that aggressive financial measures taken by the government, including the Fed's quantitative easing, were far more effective than fiscal policy in ending the Great Recession, including the Obama administration's $800 billion American Restoration and Recovery Act, passed in early 2009. Now Blinder is worried by the "sag" he's seen in the economic numbers. He thinks the Fed may be forced to resume its quantitative easing in the next couple of months if the weakness in the economy continues. How much will they purchase? Maybe $2 trillion or more of securities, doubling its balance sheet from the current $2.3 trillion in the process. That's the magnitude of an estimate that a former Fed official now on Wall Street proffered to Blinder. Most startling, however, is the recent conversion of James Bullard, president of the St. Louis Fed and a member of the Fed's policy-setting Open Market Committee. Long an inflation hawk, he's now calling for the Fed to be prepared to crank up the monetary printing presses and, in Jim Cramer lingo, "buy, buy, buy." He worries that America is falling into the deflationary trap that has gripped Japan for much of last 15 years. In a chart-laden research paper to be printed in the Federal Reserve Bank of St. Louis Review, Bullard argues persuasively that low interest rates can have the perverse effect of fanning rather than stifling deflationary expectations and therefore inhibiting economic growth. To change the defeatist psychology of corporations and consumers, he wants the Fed to be ready to make massive purchases of government bonds. It's a sensible plan. The only way to get folks out of their funk is to convince the market that the Fed will buy whatever is required to fan modest inflation and be prepared to act on it. That way the Fed might be able to keep the proverbial Paulson bazooka in its pocket much of the time. Weakness in the headline numbers for, say, inflation and second-quarter GDP growth is signaling trouble ahead for the economy. Even more menacing, however, are developments deeper in the financial plumbing of the U.S. Barron's editor and columnist Randall W. Forsyth has recently highlighted the worrisome drop in two-year government notes, to a yield of near 0.5%. Occupying the netherworld between the zero-bound fed-funds rate and the 3%-yielding 10-year notes, the two-year rate in Forsyth's view is exerting a relentless gravitational pull downward on longer-term bond prices. A broad pancaking of government yields would, of course, be Exhibit A in any U.S. descent into acute, Japanese-style malaise. Northern Trust economist Paul Kasriel worries about several other disconcerting signs in the U.S. financial system. For one thing, despite a lengthy period of fiscal and monetary stimulus, the growth of the money supply, as measured by M2, has remained far below healthy levels. Then there's the steady decline in banks' lending to businesses. And while the Fed pumped $1.3 trillion into the banking system through quantitative easing, the banks have deposited a trillion dollars with the Fed rather than lend it out, simply to earn 0.25%. Kasriel attributes this timorousness, this hoarding of capital, to bankers' concerns over a rise in their future capital requirements and over feared loan losses on commercial real estate. Deflation is anything but an errant concern, despite the U.S.'s long post-World War II history of the opposite—endemic inflation. Prices during the first three years of the Great Depression fell some 10% a year. Commodity prices during that period fared even worse. And Moody's econometric models are signaling that the U.S. might slip into deflation, albeit temporarily, by late this year or in early 2011. "The deflation should be comparatively benign, but it's still worrisome given the fact that unemployment currently stands at 9.5% and we see a one-in-three chance that the deflation will be accompanied by a recessionary double dip," Zandi of Moody's tells Barron's. Once an economy succumbs to deflation, it's often hellishly difficult for a nation to escape the trap. Companies and consumers alike tend to defer their spending on the assumption that prices for goods and services figure only to get cheaper in the future. Real interest rates spiral higher, making debt burdens all the more onerous. Forced collateral liquidations result, driving asset prices ever lower. So it's more than likely that the big artillery of quantitative easing will be unleashed to push the economy out of its despond. It's high time to get out the money-printing machines. Damn the risks of triggering a bit of inflation and some modest investment bubbles. The alternatives are far worse. http://online.barrons.com/article/SB50001424052970203550704575399211110915630.html#articleTabs_panel_article%3D1 ________________________________________________ Send list submissions to: Marxism@lists.econ.utah.edu Set your options at: http://lists.econ.utah.edu/mailman/options/marxism/archive%40mail-archive.com
