What To Do If There's a QE3? --or-- Is This 1933 All Over Again?

Quantitative Easing is nothing but a planned inflating.


[Beautiful rabbit bubble image created by Iman Sadeghi]

To be sure that everyone understands this phrase, let's look at the definition of "inflation":

Inflation ... 2a) an increase in the amount of money and credit in relation to the supply of goods and services b) an increase in the general price level, resulting from this, specif., an excessive or persistent increase, causing a decline in purchasing power. (Source: Webster's New World College Dictionary, 4th ed., 1999.)

In other words, Quantitative Easing is the Federal Reserve's attempt to support the economy, general prices, and asset prices (e.g., the stock market) by purchasing government bonds with nothing but its own full-faith-and-credit, backed, of course, by the full faith and credit of the U.S. taxpayers. In effect, the Fed is performing 2a) to achieve 2b). (The decline in purchasing power is just an incidental but not unattractive side-product, at least to the Fed governors' way of thinking.)

Does the Fed really know what it is doing? Let's look at history.

Back in 1933, a little known economist named Edward C. Harwood took a look at the Federal Reserve's intended "planned inflating" of the day. (Harwood later came to dislike using the word "inflation" when referring to 2a) above, and so he substituted the word "inflating," to avoid any confusion.)

Harwood was shocked to learn that anyone was actually considering a planned inflating as a stimulus to cure the Great Depression. He had observed through his statistical work that by 1933 the economy had rid itself of the causative factors behind the crisis, and that business was poised to make a comeback. Interference by government was the last thing the economy needed. Yet here came the politicians and Federal Reserve officials contemplating intervention.

In an article appearing in The Bankers Magazine of New York, Harwood wrote the following (I have substituted "inflating" for "inflation" where necessary):

"[T]here are several possibilities with respect to the scheme itself. It may work as planned and actually cause a return to the general price level of 1926, or at least a movement in that direction of substantial proportions. It may not work at all. It may prove to be unmanageable and carry on to an indefinite expansion of credit and currency which will finally render the dollar valueless. Unfortunately, the historical record suggests that the last named possibility is perhaps the most probable of the three. In any event, it is obvious that every businessman and every investor will be faced with the problem of adjusting his affairs to the new possibilities....

"It is clear that anyone who believes that the attempted inflating will be abortive and without substantial effect will not change his present course of action. However, those who anticipate a recovery and higher prices in general, as well as those who fear an indefinite expansion and ultimate collapse, will surely act with a view to taking advantage of the situation, at least to the extent of protecting themselves. Careful consideration of just what this will mean in the case of each type of individual mentioned will prove illuminating....

"The owner of equities has nothing to fear from inflating, in fact, is apt to gain thereby, [if he or she thinks the planned inflating will be successful;] but the position of the bond owner is vastly different.... [T]he obvious remedy for the situation is to sell fixed income securities and buy equities.

"If, however, the holder of bonds and mortgages fears a runaway inflation [hyperinflation], he may attempt to convert his securities into gold for the purpose of hoarding it....

"The situation of the depositor who has savings accumulated and of the man who owns life insurance policies is similar to that of the bond owner. In the first place, the value of dollars on deposit will decline, in terms of goods, during a period of inflating. It is quite obvious that it would pay depositors to withdraw their funds and buy equities or commodities of some kind. Those who feared that the dollar would go the course of the German paper mark would naturally withdraw their savings, and also their cash surrender values in the case of life insurance, in order to hoard gold.

"It follows that if the inflating is assumed to be effective, the banks will be called upon to pay out vast sums to depositors at the same time that the bond market is flooded with securities for sale. Banks and insurance companies will also be sellers in order to meet demands for cash or cash surrenders and complete demoralization of the bond market would result. It is hardly necessary to add that this would mean the closing of every bank in the country.... [This happened a few weeks later.]

"The truth of the matter is that inflating is the road to ruin. Deliberately planned inflating only makes the road so much the shorter because it points the way for even the most ignorant to see. Inflating can only 'succeed' by fooling most of the people all of the time. That anyone would be fooled concerning a measure which would be fought over in both branches of Congress and in the public press, is beyond belief....

"Those who advocate even the least degree of planned inflating are attempting to set in motion forces which will bring utter ruin, not only to their puny schemes, but to our whole economic fabric. Words are too weak to express adequate condemnation of those who, like children with a complicated toy, are willing to destroy that which they do not understand."

Today's Kitco gold chart gives us an interesting counterpart to his views:


[Kitco gold chart, 8/22/11, 4:30 p.m. EDT]

Today, I would say that the American economy is not in the same place Harwood found it to be in early 1933. We are faced today with another year and a half of "regime uncertainty", a major factor in our current stagnation. However, the market show must go on.

As a result of all the confusion, the market has multiple personalities these days (just like my Sybil). A third of it believes QE3 will be "successful," i.e. it will turn the stock market into a winner. A third believes the European problems will destroy the stock market but reinforce the U.S. Treasury market and dollar hegemony, in spite of QE3. Another third thinks we will see a flight from the dollar and maybe even a worldwide plunge into a Double Dip, just like in 1933.

What do you think?

Ben Bernanke: "Let Them Eat Cake!"

[Photo of Marie Antoinette from Wikipedia]

According to Robin Harding's article in today's Financial Times, our Federal Reserve Chairman is convinced the Fed's QE2 program has nothing to do with worldwide rising food prices. In response to a question on the subject, Bernanke says:

"I think it's entirely unfair to attribute excess demand pressures in emerging markets to US monetary policy, because emerging markets have all the tools they need to address excess demand in those countries...."

I will not harp on the fact that I don't agree with Bernanke. First of all, no one really cares what I think; and secondly, I don't have the scientific ammunition to prove him wrong, even though evidence to the contrary is clear to me.

What I can point out, however, is his twisted sense of noblesse oblige. To make the above-quoted statement, he must have made one of the following assumptions:

A. An increase in the issuance of U.S. dollars without a corresponding increase in U.S. GDP has no effect on foreign nations; or

B. An increase in the issuance of U.S. dollars without a corresponding increase in U.S. GDP may have an effect on foreign nations, but they can control that effect by tinkering with their own monetary unit, which tinkering is effective and has no deleterious effect; or

C. An increase in the issuance of U.S. dollars without a corresponding increase in U.S. GDP may have an effect on foreign nations, but who cares.

Bernanke may not have the gall to choose C, as did Nixon's Treasury Secretary, John Connally. Faced with a similar question, Connally is reported to have said: "[T]the dollar is our currency but your problem...." No, this would sound too flippant, too frank, and would not correspond to Bernanke's more academic, more convoluted style.

So let's assume Bernanke has chosen B above.

In support of this assumption, Bernanke might cite the example of China. China has simply absorbed any excess dollars by investing them in U.S. treasury bonds. (Don't look now, but China clearly has no other choice. If it stops squirreling away its excess foreign reserves, the dollar will tank even faster and take the value of the reserves with it. And by the way, if you look hard enough you'll notice that China is slowly diversifying away from U.S. dollars.)

Bernanke doesn't seem to care that other countries may not have China's leeway. He explains, "They can, for example, use monetary policy of their own. They can adjust their exchange rates, which is something they've been reluctant to do in some cases."

But ... isn't that illegal currency manipulation? In fact--isn't that what we're doing??

Oh well. I guess two wrongs make a right.

If you ask me, Ben and Marie Antoinette have something in common. It's called Hubris.

The Bernanke Putt

Helicopter Ben is now turning to golf, according to an article by Jon Hilsenrath and Jonathan Cheng in today's Wall Street Journal.



I can't decide whether that feeling in my gut was pain, wrath, or an ironic chuckle, when I read the following:

"The Federal Reserve is close to embarking on another round of monetary stimulus next week ... despite doubts about the wisdom and efficacy of the policy among economists and some of the Fed's own decision makers.... Fed Chairman Ben Bernanke's push to restart the bond-buying program--a form of monetary stumulus known as quantitative easing [QE]--has been greeted with deep skepticism among some of his colleagues.... Mr. Bernanke has used the analogy of a golfer with a new putter: Unsure how it will work, he finds [the] best strategy is to tap lightly at first and keep tapping until the golfer figures out how best to use the putter."

All this is fine and good, Dr. Bernanke, but shouldn't you have gotten your golf practice in well before now, at some prior time when the whole world wasn't watching your every twitch? Do you have any idea of the potential consequences of a misjudgment on your part? According to the WSJ, one of the fellows on your own team, Thomas Hoenig, calls the Fed's up-coming actions a "bargain with the devil."

My previous posts have referred to a slow-motion movie that we are all watching. I have mentioned that at the climax the Fed will find itself between a rock and a hard place: the choice whether to act or not to act.

This is happening right about now, and the Fed has decided to buy bonds. Yet Bernanke has just blown the Fed's reputation as a team of expert economic monetarists capable of curing the second worst economic crisis the world has ever seen, by comparing it to a novice putter trying out a new golf club. Frankly, I'm not sure which is more disquieting.

So now we're pretty sure the Fed will perform QE. Everyone is now asking, will we get inflation or not? First, I'll have to refer you to my previous posts about the definition of "inflation," to remind you that when the media refers to "inflation" they are (incorrectly) referring most often to "price increases," and not the increasing of money supply.

QE is inflating (increasing of the money supply), under the true definition of the word. Whether or not it translates into general price increases is a separate issue that depends on other factors above and beyond the simple act of increasing money supply.

It depends, for example, on the business community's reaction to the results of the November elections, and on the future Congress's subsequent successes or failures. QE might translate into higher general prices, or it might just become higher stock prices, independent of the CPI. It might translate into higher bank bonuses, independent of the CPI. It will certainly translate into a much lower dollar, quite independent of the CPI.

Some recommend TIPS as protection against "inflation" (price increases), but already the TIPS are selling at a premium, so the protection they offer is eroded. And TIPS don't protect us against the effects of a weaker dollar as buyers of our regular bonds reduce their appetite for same. What is the consequence of this? We may soon find out.

What's certain is that Bernanke doesn't seem to care: he's out playing golf.

Why Gold is Up in this Deflationary Environment

I've run across an excellent commentary at The Privateer, entitled "Puzzling - Gold is Going Up Again." He is responding to an August 20, 2010 article on CNN's Money.CNN.com.

As the Privateer points out, some analysts are scratching their head trying to figure out why gold is rising even as inflationary fears are subsiding. This seems counterintuitive.


[Thanks to Dhirajranka.com for the photo.]

Mr. Privateer puts his figure right on the answer to the quandary: monetary inflating. Some call it quantitative easing (QE). We could also call it Helicopter-Benning, or, as the more old-fashioned among us would say, printing money.

The U.S. central bank is finding itself between the proverbial rock and hard place. The rock: stagnation in the American economy. The hard place: The limitation of its power to do anything about it. But they can't just sit there; they have to act. They're supposed to be controlling this thing.

So the Fed Governors--at least a majority of them anyway--seem to have taken this line of conduct:

When in doubt, pull the checkbook out, and make the bogey-man pout.

Ben Bernanke, the figurehead of this majority, once swore to Milton Friedman that we would never see a deflationary episode like the Great Depression of 1929. Some astute analysts are claiming that we are indeed already seeing the deflationary episode, only it is disguised behind a wall of monetary inflating.

Mr. Privateer is one of them. Here are Mr. Privateer's words:

"Not only is 'quantitative easing' inflationary, it is the absolute last resort of the entire inflationary process. Inflation being defined as an INCREASE IN THE TOTAL STOCK OF MONEY. There are quite a few people out there in the world, and in the US too, who understand what inflation is. These same people understand that rising prices are one amongst very many RESULTS of inflation."

[Ah, a rational human being at last!]

"These same people understand that the destruction of 'wealth' measured in terms of money which has taken place over the GFC [I assume this means Global Financial Crisis] to date has more than offset the creation of new money which governments in general and the US government in particular have been desperately resorting to."

"There is not the slightest chance that there will emerge any GENUINE way out of the GFC until such time as the gargantuan malinvestments propelled by the credit money boom which has now collapsed are liquidated on a market. Every day that this is delayed makes the situation worse. Every new 'Dollar' created by governments and their banking system makes the situation worse. Every new Dollar created in this manner is inflation, pure and simple. The fact that prices are rising or falling has nothing to do with it. Inflation is an increase in the stock of money."

My heart pitter-pattered as I read this. One could hear my sighs of genuine relief at not finding myself alone in this cold world.

The author is correct. I would just add that the nation's "regime confusion" is also contributing to the stagnation. (Robert Higgs calls it "regime uncertainty.")

The question is: what do we do?

Here is the Privateer's response:

"The [CNN] article concludes with the assertion that once the GFC is 'over', there will be no reason to own Gold. The problem is that the GFC will not end - or even properly begin - until money can no longer be 'created' out of thin air. Today, while the Europeans are making some moves towards reducing their deficit spending and while Asia is losing its appetite for US Treasury paper, there is no sign of that happening."

Couldn't have said it better myself.