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ZIRP, QE and a Permanent Economic Slump
By: Steven Hansen
This past week Nobel Laureate Paul Krugman mused:
..... if our economy has a persistent tendency toward depression, we’re going to be living under the looking-glass rules of depression economics — in which virtue is vice and prudence is folly, in which attempts to save more (including attempts to reduce budget deficits) make everyone worse off — for a long time.
Professor Krugman's post was monumental in so many ways as it appeared to be a departure (or movement) from some of his positions. Consider his "new" thoughts which I find fully consistent with the New Normal:
.... evidence suggests that we have become an economy whose normal state is one of mild depression, whose brief episodes of prosperity occur only thanks to bubbles and unsustainable borrowing ....
.... Why might this be happening? One answer could be slowing population growth ....
.... Another important factor [for the mild depression] may be persistent trade deficits ....
The main crux of the Krugman argument is that the Fed should maintain its easy money policy (aka zero interest rate policy [ZIRP] and quantitative easing [QE]) as the American economy is mired in a mild depression.
Where is the evidence that monetary policy can do any more than guide an economy for short periods of time. I cannot produce a single chart to evidence QE is working, nor can I produce a single chart predicting with any degree of confidence what the economy would look like today had there been no QE.
What is disillusioning most main stream economists at this point was the high expectations of the effects of the easy money policies of the Fed. My positions on easy money are a matter of record - I have consistently suggested that easy money policies do not work because the dollar is global currency. Monetary policy leverage on the USA economy is subject to significant leakage.
- How many know how many dollars are in existence outside the boundaries of the USA in foreign bank accounts?
- How many dollars are originated in foreign banks?
- What is the foreign value of loans originated in dollars?
- Of the estimated $18 trillion dollars of international trade, how much of it is settled in dollars?
USA monetary policy effects every dollar in existence - whether it exists in the USA or outside the USA. Low interest rates for dollars mean dollars can be used for low cost loans anywhere in the world to fund expansion. Dollars will flow in search of the highest return - which again can be anywhere in the world. Read up on carry trade - I have personally used this to finance corporate projects outside the USA.
I muse whether the Fed can do any more than guess at the proper monetary policy. I ponder the endgame of QE: If the argument is that QE helps an economy, then shouldn't the disposal of QE assets hurt an economy?
How can one ever dispose of QE assets unless inflation takes hold making the QE assets worth a lot less? And inflation is not cooperating.
Another question that is little talked about: Does QE ever need to be unwound? Can't the MBS (mortgage backed securities) simply be held until they mature or default?
Can't the Treasury securities part of the Fed balance sheet be held forever, simply rolling over maturing securities into new ones?
Why can't the Fed balance sheet continue to grow as long as the (permanent?) slump continues?
When inflation exceeds desired expectations, Fed balance sheet assets can be sold which will drain reserves from the banking system and indirectly reduce credit creation in the economy. Thus inflation can be reduced by this monetary maneuver even in the absence of a fiscal response to control inflation through increased taxation.
But, I hear someone cry out, the Fed will lose a lot of money if they sell Treasuries in a higher interest rate environment at a reduced price. I don't understand that concern - How can the Fed, which has been subcontracted by the U.S. Treasury to create the currency of the land, lose money?
They create money.
No matter how you cut it, ZIRP is a tax on the middle class. It effectively lets the government and big business use money at little cost - while retirees and individual savers get no return on their life savings. Or maybe that is the plan - try to force spending on the middle class (at the expense of reduced saving).
Whatever the case, there is no proof that easy money is helping the majority of Americans and there is no proof that removing easy money won't hurt them.
Other Economic News this Week:
The Econintersect economic forecast for November 2013 again improved . There is no indication the cycle is particularly strong, as our concern remains that consumers are spending a historically high amount of their income, and the rate of gain on the economic elements we watch are not very strong.
The ECRI WLI growth index value has been weakly in positive territory for over four months - but in a noticeable improvement trend. The index is indicating the economy six month from today will be slightly better than it is today.
Current ECRI WLI Growth Index
Initial unemployment claims went from 339,000 (reported last week) to 323,000 this week. Historically, claims exceeding 400,000 per week usually occur when employment gains are less than the workforce growth, resulting in an increasing unemployment rate.
The real gauge – the 4 week moving average – improved from 344,000 (reported last week) to 338,500. Because of the noise (week-to-week movements from abnormal events AND the backward revisions to previous weeks releases), the 4-week average remains the reliable gauge.
Weekly Initial Unemployment Claims - 4 Week Average - Seasonally Adjusted - 2011 (red line), 2012 (green line), 2013 (blue line)
Bankruptcies this Week: Privately-held Scrub Island Development Group, TranSwitch
Data released this week which contained economically intuitive components (forward looking) were:
- Rail movements growth trend is continuing to accelerate.
All other data released this week either does not have enough historical correlation to the economy to be considered intuitive, or is simply a coincident indicator to the economy.