I suppose it wasn’t supposed to just slip under the radar of other events but that is how it has come to pass. The great Keynesian folly, that an economy can be resurrected from the demand side, is about to be pushed one more time, on this occasion by the Federal Reserve in the US. Flood the markets with more US dollars, that will work a treat, just as it has on the two previous occasions that this same strategy has been used. What is one really to make of this:
The Federal Reserve fulfilled expectations of more stimulus for the faltering economy, taking aim now at driving down mortgage rates until an improvement in unemployment that the central bank says will be a problem for several years.
The Fed said it will buy $40 billion of mortgage-backed securities per month in an attempt to foster a nascent recovery in the real estate market.
Do these people never learn?
More along the same lines: George Will has a column today on these same issues which the folks at Powerline have nicely titled, “The Fed’s Monetary Morphine”. The frame for the story are the views of Esther George, the President of the Federal Reserve in Kansas City. This was the part of the story that caught my eye:
With corporations holding upward of $2 trillion in cash, and 30-year mortgages at 3.5 percent, George, speaking several weeks before this week’s meeting of the Federal Open Market Committee, asked: ‘Is there anyone not borrowing today or purchasing a house because interest rates aren’t low enough? Do we expect that businesses will hire if their long-term rates are lower?’
Very low interest rates discourage saving, punish retirees living off interest-bearing assets and, George says, ‘incent people into riskier assets.’ These include commodities, farm land (for the first time on record, prices of cropland in George’s district have risen more than 20 percent for two consecutive years) and equities.
Low interest rates do not give an economy momentum, it is the availability of saving that does it. The Keynesian low-interest mantra/mania is coming to an end and the classical theory of interest rate adjustment is coming back into play. It’s a painfully slow return, but if you would like to understand the underlying theory better, have a look at the last two chapters of my Free Market Economics. From what Esther George has said, you would almost think she’d read the book herself but she probably read Wicksell instead. That’s where I found it too, from a book written more than a century ago.
Don’t worry. It will work this time.
I read an account of this somewhere today where it was described as ‘quantitative easing’. Since when did printing money become ‘quantitative easing’?
Well…clouds and silver linings. Look on this as another trading opportunity, but be sure to pass your losses on, sell your horse before it dies.
Helicopter Ben is doing exactly what he promised, dropping bales of money from virtual helicopters…..he’s a student of the Great Depression you see.
Ah, it was just a matter of time before Steve hyperventilated.
Seems not.
They know what they are doing Steve. It is intentional.
Economic collapse will come in the USA before 2016 under Hussein Obama. Vote for him, get what you deserve I guess.
No need to concern yourself Steve.
JC thinks its just dandy and why has it taken them so long?
The answer to the first is they like playing ‘Repeat Offender’
The answer to the second: Election 2012.
Are those mortgages at the old house value or what they’re currently worth?
Isn’t the best stimulus achieved by the Government keeping its grubby mitts out of the public’s wallets?
Well, if they do it in sufficient quantities, they’ll certainly get people spending. The Fed has the ability to create as much money as is necessary to purchase evrything and anything and so people will at some point try and rid themselves of the excess supply of money. The question is will that spending, either on assets or goods and services translate into increased output and employment? That is unlikely. Production, and not merely spending is the source of growth and prosperity…one can argue that if consumers are spending, it will give producers the certainty they need to invest and produce. But WHAT they produce matters. Will it match consumer preferences? Also, will consumer preferences be altered by the flows of newly created money? I’d say not sure to the first question and yes to the second. But will consumer preferences be altered in a predictable way? I’d say no.
Will it lead to inflation? That is the more likely outcome. The problem is that the US economy and other economies are structurally unbalanced and printing money will do nothing to change that. I am sympathetic to the argument that money should be created to offset a deflationary monetary disequilibrium (excess demand for cash), but the problem is that we can never directly observe monetary disequilibrium, rather we can only see the symptoms when they appear…so, do you have faith in the Fed to recognise the appearance of an inflationary monetary disequilibrium, when the market monetarists have been ranting that the Fed has been unable to spot, or unwilling to respond to deflationary monetary disequilibrium?
Even the advocates of market monetarism such as Scott Sumner have been pointing to nominal GDP as the only indicator of monetary ease or tightness – that is, he admits that he cannot observe monetary disequilibrium. Do we have a good knowledge of the lags involved in the use of monetary policy, especially on such a large and unprecedented scale? I’m the sort of person to acknowledge my shortcomings and say no way. The key to Sumner’s strategy is to announce a nominal GDP target and thereby the Fed will somehow magically attain credibility and overcome any time inconsistency problems that comes with discretionary policy. This is a massive experiment and I just can’t see it working. Plus, the unintended consequences are likely to be huge.
In my humble opinion, the Fed is about to unleash a much bigger cycle…be prepared folks…that’s all I can say!
The only way to tame the cycle (but not eliminate it) is for markets to be as free and flexible as possible and no amount of money creation can alter that reality…
Do not approve.
As an aside, I would assume Obama’s reelection chances just skyrocketed.
They will do the same under Romney, there is no choice anymore, market interest rates would destroy most economies, ZIRP or LIRP is here to stay. We all know it, but it feels good to say otherwise, does it not. Free markets are dead pretty much.
You folks actually think Romney can change all this? How? Please do explain, cut military spending? Pfft, he wants a stronger military. Cut entitlement and transfer payments, like hell, 48 million on food stamps, a labor fprce the equivalent of 1981, like hell he will cut them. Going to fix the health system is he, really, like hell he can. Social security, done, trust funds have been raided, and full of treasuries now, soon to be replaced with this worthless mortgages being bought by the Fed
16 Trillion deficit, naaa, thats just a kid stuff, try 70 Trillion+ with unfunded
Romneys going to fix that is he? Or is Romney just SAYING he will fix it? What is it you want to hear today? 
What will make you feel better 
Obama will win and will win well, 48 million on food stamps is a good starting point.
Doesnt matter folks, both parties are done, the money must flow, the looting must continue.
Sarah Palin Facebook:
I did overlook the fact that Romney/Ryan have stated they will balnce the budget. Really, how (read prev post). Its easy to say though isnt it, let me try “We intend to balance the budget”. Damn that was easy…
Sarah Palin? Newt Gingrich, Rick Santorum? These were the alternatives? God help them, look in the mirror then thibk about that. See if you laugh
Excessive liquidity and artificially low interest rates leading to asset price speculation. Straight from the Alan “Bubble Boy” Greenspan handbook.
Just make sure you’re out before it collapses again.
I am buying gold.
CRC (Cortona Resources)
I like their fundamentals and their upside.
VDH on how the persistently low interest rates on the US are destroying the culture of saving:
If US companies are sitting on $2tril and rates are at 3.5% perhaps the problem is too much saving.
“This temporary, artificial economic “stimulus” bought at the expense of high inflation is no substitute for a stable currency and genuine long-term economic recovery.”
High inflation? I’d better go buy a wheelbarrow.
http://www.businessspectator.com.au/bs.nsf/Article/Ireland-tax-debt-crisis-investment-economy-eurozon-pd20120914-Y5352?opendocument&src=idp&emcontent_asx_financial-markets&utm_source=exact&utm_medium=email&utm_content=103461&utm_campaign=kgb&modapt=commentary
A good article on how internal devaluation/deflation can be successful.
This is due to the Fed paying interest on excess reserves. If they ditch that, then you will need your wheelbarrow (and a gun) if you are residing in the US…
We might be on the verge of a crisis, which means that there are opportunities for the outriders who can see the barbarians at the gate.
Inflation and Gold? I wish I knew, it makes sense, but there are so many governments determined to keep the price low, and effectively sell paper gold. Sooner or later investors are going to click that there is 100 times more paper gold than there is actual metal on earth. But When? Some Investors are so dumb they will buy Bonds from the Europeans.
Does this improve Obama’s chance of re-election? That does not make sense at this time. But if he does get re-elected we had better hold tight, cos its going to be an interesting journey.
What the hell, even if Obama loses this election, the Ivy League, NYT and Wall Street have already developed their prototypes for versions 2, 3 and 4S.
“Are those mortgages at the old house value or what they’re currently worth?”
What are they currently worth? Maybe 20c in the dollar – no-one really knows, as none of the MBS tranches have been properly priced by sale (but rather held on the books as full value assets), due to the sudden abeyance of the accounting rules after the GFC requiring such “assets” to be marked to market.
This accounting chicanery hid the fact that all the major banks would have been technically insolvent after the property bubble, and would lose their trading licences.
In other words, the Fed is paying 2005 prices to the banks, who can off-load their virtually worthless (at today’s value) MBS portfolios.
The Fed has now become the “bad bank” of last resort, with the inbuilt benefit that as a private institution, it is not subject to audit requirements.
The banks get recapitalised, and can spend their freshly printed dollars on, oh, let’s say oil and futures, commodities, farmland, or anything they want that turns a profit on loans. This will have the inevitable consequence of price inflation, and quite possibly more bubble-blowing in oil, commodities, and/or food production.
All backed by the US taxpayer.
This will not end well.
Looks like the Fed needs to learn some old wisdom.
“If at first you don’t succeed, try again. Then give up – there’s no point in making a damn fool of yourself”.
They are making damn fools of themselves.
Some very good observations Kaboom…
I concur, this will not end well…
skuter, I doubt it is IOR that is keeping inflation at bay, but without that there would be less need for QE.
The problem I have is that there is a difference between saying AD is not a solution and AD is not a problem. Sometimes you have to clear a problem before a solution can work.
Kaboom,
The Fed is audited every year by external auditors, in this case the largest audit firm in the world.
http://www.federalreserve.gov/publications/annual-report/2011-federal-reserve-system-audits.htm#BoardOfGovernorsFinancialStatements-5FA64451
OK, Andrew, I stand corrected.
I make the simple observation:
So too was Enron audited, by the (then) largest audit firm in the world.
Pedro, the Fed is effectively paying banks to hold cash reserves. That is the only thing restraining a much higher level of credit being unleashed. You don’t think that would generate rising prices?
I think you misunderstand Steve’s comments. AD is a rubbish concept full stop. Aggregation of heterogeneous transactions/output/capital/investment is not a valid analytical procedure and leads to erroneous thinking. Using it as the basis for policy is guaranteed to turn erroneous thinking into disastrous outcomes…
skuter, I know what IOR is. How would removing IOR create inflation or unleash a wave of lending. IIR, the reason for IOR was to feed money to banks would be otherwise struggle to find borrowers. That lack of borrowers remains, as is acknowledged in the George Will article.
As for AD, perhaps you didn’t understand my comment. AD is not a rubbish concept. The only rubbish idea is that you can create sustainable growth just by goosing it. If AD falls you will have real consequences. Long run solutions are found on the supply side. But there are no short term solutions there.
Well sort of Andrew.
The Fed refuses to allow a simple visual check of its physical bullion vs its published gold holdings. There are some unkind individuals who suggest that the PPT has sold / converted to derivatives much of that holding.
Must be just more nutters.
Kaboom,
Just a further correction – Andersen was the smallest of the (then) Big 5 firms.
Audits are no guarantee of correctness for any firm anywhere. In any case, the audit is done to Standards, and no audit is going to be better than the Standards they should be meeting.
I’d agree – it will not end well.
Errr, by cutting the incentive for banks to hoard the cash they now hold. Don’t tell me you believe that there is simply no-one willing to borrow at all under any circumstances? Surely there are people who would borrow if the interest rate they actually faced for a particular type of credit was lower?
Um, yes it is rubbish. The idea that you can add the dollar value of all transactions or types of output together (implying perfect substitutability) is just madness. If you really think that government purchases of fairy floss, for example, can replace private sector investment in new infrastructure or private consumption on (subjectively valued) useful items, then there is no helping you.
If we must persist with using AD and AS, then if AD falls, it is because AS has also fallen. The two quantities are inextricably linked.
OK, I’m just a simple bush nurse who knows only what I’ve read in life, but this looks to me like QE = flog the crap outa them printing presses.
…and hello hyperinflation.
No offense, but it looks scary when “…a simple bush nurse…” knows better economics than the Chairman of the Federal Reserve Board.
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No offense, but it looks scary when “…a simple bush nurse…” knows better economics than the Chairman of the Federal Reserve Board.
Luckily for you Andrew he doesn’t.
Yes he does.