Thursday, October 28, 2010

And QE does NOT cause inflation

QE doesn't work

Thus far, the only thing QE appears to do is drive asset prices higher without being supported by any underlying fundamental change. This is largely due to the psychological impact of QE and the FALSEHOOD that QE = “money printing”. " For the those who rush uninformed to refer to money printing read the article and the comments. There is an intresting discussion as to what central banks are up to (Bernanke in particular) and a suggestion that he is now close to impotent. There will be no drops of money from helicopters because that aint even within his powers.

Posted by bellwether @ 08:05 AM (3367 views)
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26 thoughts on “And QE does NOT cause inflation

  • From the article ”There is no historical evidence that QE actually works to lower interest rates.”

    Maybe not gilt rates, but central bank interest rates have been low.

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  • Thanks b/wether – sainity restored or is that insanity remains before people realise the king is not wearing any clothes, and then sanity is restored?

    You might find this of interest http://animalspiritforecasts.blogspot.com/ [2nd para].

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  • HPW central bank interest rates were lowered in 2008. As a policy reaction, this is related to QE but functionally it has nothing to do with it.

    Thanks Techie, I’m not sure if sanity is necessarily restored as in truth I’m never that sure what is right. I think what people like HPW sense is a determination from the powers that be to inflate assets/debase currency at all costs, and I suppose from the peprspective of a prudent saver interest rate policy and bank bailouts must feel something like that.

    My problem all along has been a simple one ie an adequate explanation as to how we go from the current policy to inflation. QE while swapping bank assets (which may be impaired but are far from worthless) for treasuries doubtless improves the capitalisaton of the banks in question but that capitalisation has to find its way into the economy ie the banks have to lend in an environment where there the reduced numbers of potential good debtors are reluctant to borrow – afterall if the creditworthy were going to borrow they surely would have during the credit binge.

    I suppose that hand outs and benefits might be seen as inflationary as they are payments in exchange for no productive activity (except perhaps surety against the unemployed turning to crime) but these are not increasing. Wage increases beyond the current rate of inflation would be inflationary but these are not happening. Commodity price spikes are not prima facie inflationary (a) because they are likely based on temporary speculation but (b) more significantly because these increases are not met by money printing ie we can’t afford oil at $100 a barrel let’s print more money.

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  • This guy is basically saying that the past is a good guide to the future. In a way, it’s sad that he is so absolutely correct. It’s not too much of a leap to say that mankind’s greatest flaw is the inability to learn from his mistakes. He is also absolutely correct about QE. It is paper shuffling from one side of the ledger, to the other. Anyone who claims that the UK version of QE directly causes inflation does not fully understand its’ mechanics. The determinedly ignorant claim that the British version of QE is simple ‘money printing’. It is not. The UK version of QE was designed to curtail the banks’ ability to make money without bothering to lend to businesses and individuals. It didn’t even achieve that because they still didn’t lend. QE might have been put on hold for now but I imagine they will reach for it again at the first sign of stress, no matter what history tries to tell us. When they do, it still wont cause inflation and it still wont be ‘money printing’. Good find bellwether.

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  • The comments are helpful to anyone who wants to think a couple here

    “Krugman is one of these guys that believes you can talk inflation into an economy. In Japan he was in favor of targeting an inflation rate as high as 300% if it needed to be. He thought that would just get everyone to react and respond differently. I know the Fed likes to herd people around and whatnot, but that’s just not how it works in the real world. When I don’t have money to spend because I have too much debt my spending is dictated by that and not by what some guy in Washington is saying.

    Krugman has long admitted that QE does nothing except alter perceptions, but he still advocates the policy. Now, here we are with a mountain of evidence showing that it doesn’t do anything and more and more qualified market practitioners coming out against the policy every day and PK feels the need to defend himself by saying that surging commodities don’t matter.

    He needs to ask Kimberley Clark and ArcelorMittal if rising commodity costs matter. Better yet, ask them how that will influence their hiring trends.”

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  • and here

    ” According to Hyman Minsky’s analysis of the financial cycle — which Richard Koo is using also, as well as the MMT’ers — this is the culmination of a long financial cycle that ends in what Minksy called “Ponzi finance,” which is the use of leverage to service leverage, banking on ever-increasing asset prices, which is of course unsustainable. The resolution of the inevitable debt-deflation crisis involves deleveraging and rebuilding balance sheets, and liquidation of malinvestment before a new financial cycle can begin. If this is not handled properly by the monetary and fiscal authorities, a depression can develop, although this is reduced with the automatic stabilizers now in place since the Great Depression.

    Instead of diagnosing and treating this, the people in charge are acting like this is a business cycle alone, whereas it was the ending of the financial cycle that spilled over into the real economy. As a result they are misdiagnosing the issues and mistreating the problem.

    On one hand, the fiscal arm (Congress) is side-stepping the problem by not providing enough space for deleveraging and saving to rebuild balance sheets, as well as to close the output gap in the real economy. The stimulus was too small and not well directed. However, Warren Mosler thinks that it was large enough and still has enough oomph left to lift the economy more, along with the ongoing automatic stabilizers. So, it that there are green shoots again, even though fundamental financial indicators are rotten at the core owing to a mountain of toxic debt. However, if fiscal austerity would be implemented after the election, all bets are off, since a turndown in the real economy would exacerbate the financial situation by making debt more difficult to service.

    On the other hand, the monetary arm (Fed) is perpetuating the stage of Ponzi finance by trying to lift asset prices and “create some inflation” by raising the price level. However, true inflation only occurs as funds available result in nominal aggregate demand that exceeds the productive capacity of the real economy to respond with supply. Therefore, the Fed is trying to wag the dog’s tail, and the dog is just going to get annoyed and bite the hand.

    Turning to another issue, the Fed can control the yield curve through purchasing long bonds, but this could involve a lot more buying than the Fed is up for, so inadequate QE could provoke (erroneous) inflationary expectations resulting in interest rates rising a bit, as the data above suggests. If the Fed wants to drive up LT bond prices, it has to be prepared to do what it takes, as long as it takes, and I doubt that Fed members have the stomach for this now, with the economy not actually tanking (yet).

    I agree that the Fed is (surreptitiously) buying up dreck, and likely intends to eat it, which is really a disguised fiscal operation that Congress probably won’t like one bit once it realizes that the Fed is end-running it. Another example of the command economy at work, doing things that don’t work as planned. “

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  • bellwether: As I said above, QE was designed to curtail the banks ability to make money without bothering to lend to businesses and individuals. It would have succeeded if they hadn’t simultaneously imposed harsher Capital Adequacy rules. The harsher rules were necessary but were imposed in a reactionary, populist fashion. They should have delayed the new Capital Adequacy rules, until the recovery was well established. There are some parallels to the ‘spend in a recession’ argument. Of course, spending in a recession only works if a government saves in the preceding boom. Our previous government went into deficit during the boom, which is perhaps the greatest economic crime of all. We should undoubtedly be ‘spending big’ in this recession but we were robbed of the ability to do so, by the preceding 10 years of poor economic stewardship

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  • Thanks Flash. I read some interesting comments from Jeremy Grantham the other day that broadly support my view that we have a cyclical dip, accompanied by the end of a credit cycle.. It is this dual element that leads me to wonder whether matters will recover quckly this time we are in for what Grantham calls 7 lean years or Albert Edwards a sort of mini ice age that precedes a credit bust.

    In my line of work I am close to the banks reaction to people who borrowed against commercial property and it is rarther schizoid. In the recent good times the banks lavished these guys with money, now they are putting them down often for little or no reason (eg the breach of some notional LTV ratio) I suspect that by the time the banks feel ready to lend there will be a general revulsion in relation to credit and the aysymetrical/onesided relationship a debtor must form with a bank to get credit, still needing to be worked through

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  • HPW central bank interest rates were lowered in 2008. As a policy reaction, this is related to QE but functionally it has nothing to do with it.

    As I understand it, QE keeps down the cost of government debt.

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  • HPW the cost of government debt is effectively zero as we can create all the money needed to pay it off right now and take our chances with the exchange rate. If that was the intention why hasn’t this happened? Even if this were to happen how is this inflationary – surely all that would happen would be our imports would get more expensive and our exports less so?

    As I see it to get the sort of inflation you fear (me too incidentally!) we need cash into the hands of our citizens in large and increasing volumes. Do you see that happening?

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  • On the same subject this is (IMO) worth reading

    Pimco’s Bill Gross, manager of the world’s largest bond fund, says quantitative easing has called an end to the 30-year bull market in bonds and labels current monetary policy as a ‘Ponzi scheme’.

    Full story @ http://www.investmentweek.co.uk/investment-week/news/1811510/gross-qe-ponzi-scheme

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  • mark wadsworth says:

    Spot on.

    QE is not money printing and has no particular impact on the real world outside the closed loop of the banking system.

    Yes, QE does push down the interest rates that the UK government pays, but this is mainly because long term borrowing via gilts (average period to maturity about 13 years) is replaced by short term borrowing via electronic balances at Bank of England. It’s nice to pay a lower interest rate, but if interest rates rise, then we are f—ed.

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  • “I read some interesting comments from Jeremy Grantham the other day that broadly support my view that we have a cyclical dip, accompanied by the end of a credit cycle.. It is this dual element that leads me to wonder whether matters will recover quickly this time we are in for what Grantham calls 7 lean years or Albert Edwards a sort of mini ice age that precedes a credit bust. ”

    I think what will happen is that the better capitalised banks and some new well funded banks (perhaps sovereign wealth funded) will come out of hibernation at some stage to claim market share. The poorly funded banks that are unable to lend will be in trouble when this happens and they will shrink or disappear. The question is, will the more able banks lend only when they detect signs of sustainable growth or will they jump first and in effect, help create the sustainable growth. My money is on the later and I would put an 18 to 24 month time cycle on that. New banking licences are being hotly pursued at the moment and there is no shortage of investors (sovereign wealth and large corporate) willing to take a punt on grabbing a bigger share of the next recovery, whenever that may be. As soon as a couple of banks start to make a grab for market share, all the other banks (that have a decent balance sheet) will fear losing market share. As a side issue, I think a cull of the weaker banks would be very beneficial, in a growth environment.

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  • HPW the cost of government debt is effectively zero as we can create all the money needed to pay it off right now and take our chances with the exchange rate. If that was the intention why hasn’t this happened?
    That may depends on the currency that the govt, has borrowed in; but it is also the question of what the government are allowed to do.

    Even if this were to happen how is this inflationary – surely all that would happen would be our imports would get more expensive and our exports less so?
    Imports are getting more expensive for a number of reasons, as for exports, the UK isn’t able to compete with the rest of the world anyway, the cost of living here is too high.

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  • hpw: “That may depends on the currency that the govt, has borrowed in”

    no, bellwether is right. Britain’s national debt is almost entirely denominated in sterling

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  • b/wether – @ 6 -see this to whet your appeitite -[dont worry about the mention of you know what at the beginning]. Keen is a great supporter of minsky.

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  • @bellwhether – Thanks for the post.

    I think in this globalised world, it is no longer correct to look at each economy in isolation. The JPY carry trade was exporting inflation, and now the USD carry trade. That would be the real effect of QE. Also, BOE does not publish a breakdown, I am pretty interest to see how much foreign central bank have £ deposit at BoE (these are money that are not counted in M4). The foreign central bank deposit at BoE will normally be the result of someone in their country handling in a £ in exchange for local currency (and hence increasing money supply there)

    You really don’t need ‘money’ to get in hands of US/UK/Japanese citizens, as long as the money gets into the hand of anyone in the world in large quantities, you will get inflation in commodities etc.

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  • general congreve says:

    @17 – Nice post easybetman, this exactly what is happening, why commodities are rocketing in price and why countries like Brazil and China are getting the hump about capital inflows from the dollar carry trade creating inflationary pressures in their economies.

    @12 – Indeed, if interest rates rise we are f_____d. When the bond bubble bursts…

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  • “You really don’t need ‘money’ to get in hands of US/UK/Japanese citizens, as long as the money gets into the hand of anyone in the world in large quantities, you will get inflation in commodities etc.”

    It arguably doesn’t cause any money to get into anyone’s hands. Economists have started to differentiate between ‘QE’ and ‘QP’ (Quantitative Policy). Roughly speaking, QE is QP plus actual money printing and QP is QE without actual money printing. Only Japan has really done QE and the rest of us have only really done QP.

    The only way that our version of QE (which is really only QP) can cause inflation is by way of raising the expectation of inflation. Believe it or not, most economists believe that causing the expectation of inflation or deflation is all they need to do

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  • inflation in commodities etc.

    So, QE keeps interest rates down, money becomes cheaper and then the money is used to buy assets – which causes inflation in those asset prices. I think I can see that.

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  • Also, QE can make a currency weaker, so inflation can come when goods are imported.

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  • Flash you might be right about lending at corporate level picking up but I can’t see this happening to individuals where the core collateral for such lending, for as long as wages and property prices are shrinking. In a substantially consumption driven economy borrowing by individuals is very important.

    HPW it seems to me there is nothing for us to argue about. You define things in a manner quite different from me, and indeed seem to have concerns that are quite different. There seems to be insufficient common ground to enable a debate that would be meaningful for either of us.

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  • “So, QE keeps interest rates down, money becomes cheaper and then the money is used to buy assets”

    There is a credit drought. Net lending is negative or near zero, so even if QE was the cause of our current low interest rates, there is no/not enough borrowed money to chase assets upwards. A scarcity of credit is, if anything, deflationary. The cause of the very real inflation we are experiencing lies elsewhere.

    “Also, QE can make a currency weaker, so inflation can come when goods are imported”

    Most commodities and even some finished goods are priced in Dollars. America also enacted a form of QE, so their currency went down with ours and in turn China’s currency went down with the Dollar (because it is pegged to the dollar). There has therefore been little loss in commodity buying power (they are priced in Dollars) as a result of the lower Pound. Any loss of value against other currencies is limited by the fact that commodities are priced in Dollars and by the fact that our exports of services and finished goods have benefited from the lower pound (our finished goods Exports to China of all places have recently increased to almost £7 Billion). It’s worth noting that the Pound is currently trading at a level against the Dollar, which is quite healthy by historical standards. £1.5 used to be considered ‘about right’. Pre crisis, our currency was horrifically overvalued and it lost some of that value before QE was mentioned

    Again, the cause of the inflation we are experiencing, therefore, lies elsewhere. The whole point of bellwether’s article is to point out that QE has not caused inflation in the past. We should heed the lessons of history and direct our attentions elsewhere for the cause of inflation. An extra 2 billion or so people suddenly scrambling for their share of the worlds limited resources is a good place to start looking

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  • bellwether @22: Agreed. There will be individuals who are so damaged by the coming falls in house prices etc, that they will be unable to borrow and join a newly growing economy. There will also be damaged banks and companies that are unable to rejoin a growing economy. I would be very hacked off if these people and banks were “saved”. A good weeding out of the “economic idiots” will allow healthy entities to grow into the voids left by the demise of the walking dead, who are currently clogging up the system. It’ll take quite some time to sort out, by which time we’ll be half way to another collapse. No lessons learned, ever.

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  • There is a credit drought. Net lending is negative or near zero, so even if QE was the cause of our current low interest rates, there is no/not enough borrowed money to chase assets upwards.

    There is a credit drought, but I am thinking more about what the investment banks have done with the cheap money. Of course, some of the inflation is due to cheap bail out money too, not just QE. Added to that a couple of other factors too.

    An extra 2 billion or so people suddenly scrambling for their share of the worlds limited resources is a good place to start looking

    Ah yes, but I wonder why they are doing that?

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  • hpw: I’m going to follow bellwethers’ sensible lead. I’ve explained QE several times and Mark Wadsworth is also good on the subject.

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