More QE is on the way – The central banks are digging themselves a deeper hole

Dear readers, first of all, apologies seem in order. An unusual gap between blog posts has appeared on the Schlichter Files this summer. The reason is that I was travelling with my family in East Africa through most of August, enjoying the spectacular landscapes and the fascinating wildlife there, and meeting some very interesting people. Although, admittedly, I travelled in considerable comfort, and East Africa offers today reasonably good internet connections, often even in fairly remote areas, I decided not to read any newspapers, websites or even my emails for a few weeks, and instead tried to take my mind off the depressing subject of monetary meltdown and the destruction of capitalism and the free society at the hands of politicians and central bankers. So here I am, back in London after almost a month in the relative wilderness, slowly and reluctantly catching up with events in the strange world of 21st century finance. My first impression is that I have not missed much in terms of the unfolding crisis. None of the dynamics have changed. If anything, I feel my dire predictions and gloomy outlook again confirmed by recent events.

Where we are

Last month we entered the sixth year of this crisis, although parts of the media seem determined to continue calling it a ‘recovery’. Wishful thinking. We have been in continuous crisis for half a decade. Doses of Valium and Prozac – called QE among central bankers – have calmed nerves occasionally and given the false impression of healing.

QE, or ‘quantitative easing’, is, of course, the creation of massive new quantities of monetary units and their targeted injection into financial markets for the purpose of manipulating asset prices and interest rates, and of flooding the banks with extra free reserves. QE is a dangerous drug. It is a hallucinogen. It can make you feel better for a while but it won’t cure the disease. In fact, it makes you sick. The global economy suffers from grave distortions that are the result of years and decades of artificially cheapened credit: overstretched banks, too much debt, inflated asset prices, misallocated capital. Cheapening credit further – and manipulating asset prices further – is, however, the MO of QE. QE encourages additional borrowing and further balance sheet expansion.

QE – and zero interest rates – is the policy equivalent of crack cocaine. It is addictive. There is no end to it.

I was reminded of this when I opened the newspapers last Thursday for the first time in almost a month, and learned that the Fed might be on the cusp of another round of QE.

“Fed Minutes Signal Action Likely”, headlined the Wall Street Journal, “Fed shows a strong consensus for action”, the Financial Times.

Whenever the policy elite is promising more action you should get very concerned.

QE – to the bitter end

When compared to their peers among the global oligopoly of state money printers, the Fed bureaucracy has had a rather quiet spell over the past 12 months. The Fed only conducted some balance-sheet neutral bond price manipulations (‘Operation Twist’) but refrained from any money-printing worth mentioning. Since the crisis started in July of 2007, when the bottom fell out from under the US subprime market, the Fed has, of course, created a cool $1,900 billion in new money in the form of bank reserves. Its balance sheet has more than tripled. But most of this money was created during QE1 – after the collapse of Lehman in 2008, when the Fed bailed out the US banking system by taking over more than $1,000 billion of its mortgage exposure – and then during QE2 – when the Fed created another $600 billion to manipulate the prices of US Treasury securities. But in year 5 of the crisis – July 2011 to July 2012 – the monetary base has remained unchanged, for the first time in any one-year spell since July 2007.

Such impassivity is not becoming for the most powerful central bank in the world, in particular when the Bank of England is already on QE3, and the ECB has just expanded its balance sheet by more than 50 percent. (Incidentally, the ECB, the pantomime villain among international QE-enthusiasts because of its supposedly Bundesbank-inspired hard-money line, created more money, at least exchange-rate adjusted, since 2007 than the Fed: €1,800 billion. As I keep saying, when I look at the world’s major central banks, I see sameness, not divergence.)

Bureaucrats can, of course, not sit still for long. People might get the idea that they are useless and that we don’t need them, or, heaven forbid, that their work is even positively harmful. The bureaucrat cannot allow these concerns to emerge. Through ‘action’ he has to remind the public of his vital importance to society. By contrast, private companies are ventures that are ultimately controlled by consumer demand, and that are therefore usually limited in time. They emerge, grow and prosper, decline and die when consumer tastes change or better competitors come onto the scene. Not so the monopolistic state bureaucracy. It is built for eternity. Regardless of how disruptive, harmful and distortive the central banks’ ongoing money injections and cheap credit policies have been over the years and decades, and how culpable the Fed (among others) has been in creating and maintaining vast imbalances, the central bank bureaucrat has to go on with his work. He can’t question his mission without questioning his own existence.

Part of the Fed’s official mission is, famously, to boost employment. The notion behind this task – namely that lasting private sector employment can be enhanced through constant money injections and manipulations of interest rates – is utter economic nonsense. However, it is the very raison d’etre of the Fed. That is their line and they are sticking to it.

That QE3 would ultimately come was clear from the moment that QE2 had been concluded. It was only a matter of time. Yet, from the point of view of the central banker, it would be a mistake to simply resume QE without orchestrating first a protracted and well-publicised internal debate. Otherwise, the public could get the idea that modern central banking was simply ‘money printing’ rather than a difficult, complicated, and intricate affair that requires countless economic analysis and careful fine-tuning.

The Fed’s present deliberations seem to go something like this:  there is a ‘recovery’ out there, but it does not look ‘substantial and sustainable’ enough. Some higher asset prices, lower interest rates, tighter risk premiums, or more generous bank reserves – preferably, all of the above – could help the economy and make sure that the ‘strengthening’ is ‘substantial and sustainable’. Let’s print more money!

What to expect

I have no insights into what precisely the Fed is up to, and frankly, I find the expert-discussions among analysts on CNBC or elsewhere on the topic slightly degrading and cringe-inducing, akin to watching an episode of ‘I am a celebrity, get me out of here’. Do these experts realize how much we have moved away from capitalism? These financial analysts often call themselves ‘economists’ when what they are doing resembles much more the work of the Soviet-era Kremlin watchers who tried to read between the lines of policy pronouncements and the tea leaves of the Politburo.

For what it is worth, my guess is the Fed will have to do more than the lame $600 billion they did last time. And at some point they will have to also stop paying interest on the massive excess reserves at the Fed to push more money into the economy.

What will the consequences be? Will this be the straw that breaks the camel’s back? Will it push the financial system over the edge? Will it finally undermine confidence in the system? Will this trigger sell-offs in bonds and trigger currency meltdown? – I doubt it. Not yet. We may have to wait a tad longer for this. But it will undoubtedly add to the grave distortions in our financial system. The Fed’s chosen assets will get a temporary boost, some well-connected financial firms will make handsome windfall profits, and some of the economic data might improve for a while. I also think that the deflationists out there, who expect balance sheet shrinkage and drops in asset prices, will again be disappointed. Another dose of Valium will probably keep asset prices supported and also consumer and producer prices on an upward trend. All this new cash has to go somewhere. The debasement of paper money will continue. Gold could do well.

Naturally, none of this will end the crisis. It will certainly not kick off a ‘virtuous cycle’ of growth and prosperity such as Bernanke foolishly promised back in 2010 when he last engaged in QE. That this is the one ‘stimulus’ that will finally put the economy on self-sustaining growth, on the ‘substantial and sustainable strengthening’ the Fed demands, is grotesque and simply laughable. This policy will simply cement the dislocations and add more debt to our economies. It could inflate the government bond bubble – the most dangerous of all bubbles – further, and allow the US government to run even larger deficits for even longer (although, admittedly, the bond bubble continued to inflate even in the absence of QE, due to private sector ‘safe haven’ flows, although the bubble has also been supported continuously through zero interest rates and ample bank reserves, both provided by the Fed). The financial system will, on the margin, become even more dependent on ongoing Fed support and ultra-low policy rates. This will make it impossible for the Fed to ever reverse course.

The idea that all this monetary madness is only temporary, only to help us get out of the crisis, and that the central banks have an ‘exit strategy’ –a term that I have not heard or seen in any discussion of central bank policy since spring of 2011! – is getting less tenable by the day. There is no exit strategy. Not in the US, not in the UK, not in the euro zone.

In Britain, the ex-central bankers Blanchflower and Posen are demanding that the Bank of England, the global QE champion, drops its ‘anguished religious ethics’ over QE and finally buys a wider range of financial assets, and not just government bonds. Germany’s Spiegel-magazine this month reported that the ECB might establish upper yield spreads for non-German government bonds and then defend them through its own open-market bond-buying. Wherever you look, the same story: more money has to be printed in order for the central bank bureaucracy to influence, distort and manipulate an ever wider range of asset prices.

One day a sufficiently large section of the public will realize that the central bank and the government have no alternative to printing ever more money and taking on ever more debt. The only way they know of how to ‘stimulate’ the economy is via cheapening credit and encouraging more lending and borrowing. At some point, confidence will evaporate, people will disengage from bonds and paper money, inflation will rise (as money becomes a hot potato) and real interest rates rise even faster (as bonds become hot potatoes, too). Nobody knows when that will be. But we know one thing: the policy bureaucracy remains relentless in its efforts to make the widespread price distortions, capital misallocations and the gargantuan debt pile bigger. More interventions and market manipulations are on the way. All of them are designed to discourage the liquidation of imbalances and instead encourage more debt accumulation. The goal seems to be to make the endgame as catastrophic as possible.

That is the one thing the central bank bureaucrats and politicians will succeed in.

This article was previously published at Paper Money Collapse.

9 Comments

  • Paul Marks says:

    Yes – the establishment elite are determined to carry on this madness to the bitter end.

    Some are doing it intentionally to destroy civil society – but most of the establishment elite are NOT doing it with the intention of destroying civil society.

    But the effect will be the same – regardless of intentions.

  • “One day a sufficiently large section of the public will realize that the central bank and the government have no alternative to printing ever more money and taking on ever more debt. The only way they know of how to ‘stimulate’ the economy is via cheapening credit and encouraging more lending and borrowing.”

    True enough with the debt-based money system.
    My hope is that some day a sufficiently large section of the public will realize the rubric of the present private central bank “QE” construct – that of pretending to issue money, while NEVER Easing any monetary aggregate, Quantitatively or otherwise, and instead sees the benefit of resort to administration of the national means of exchange without issuing the debt.

    It’s the debt associated with issuing the money that is the cause of this global financial crisis, which is one of debt-deflation and not monetary inflation.

  • Paul Marks says:

    When govenment issues new monetary base no “debt” need be involved. It often is – but it does not need to be.

    And extra “debtless money” is NOT a good thing.

    For example, (as it seems it needs to be said) printing “United States notes” and “throwing them from helecopters” would NOT be a good thing.

    Although YES – at least it would not be a corrupt way of subsidising the banks.

    As for “debt deflation”.

    Most forms of debt are increasing – not decreasing.

    • hhmmmm….

      Just to be clear, we’re not talking about government issuing monetary ‘base’ – implying a reserve basis against which private banks multiply deposits via issuing more debt (money)

      We are talking NO reserve base, and the Treasury issuing the real money – as you said, like in United States Notes(Greenbacks).

      Of course, debt-less money issuance IS a good thing.
      But, excess debt-less money is as worthless (almost) as excess debt-money. It is the ‘excess’ that could cause inflation.

      For some reason, whenever government money issuance is brought up, there’s always a helicopter on the horizon.
      Try to assume that your favorite money-creation method were in place and the same amount were issued without debt by the government. That’s how to compare monetary system alternatives.

      This recent paper by a pair o IMF economists shows that the old Chicago Plan proposal (government issuance, full-reserve banking) could still work today, and solve a lot of our financial problems.
      http://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf

      • Paul Marks says:

        Mr Bongiovanni there is a fundemental disagreement between us on the Greenback issue.

        I would point out that Salmon P. Chase (who introduced these notes) regarded them as an emergency, Civil War finance, measure – and accepted that they were indeed inflation (in themselves – not just because they caused higher prices in the shops).

        To regard wartime desperate measures as “of course a good thing” is odd – especially as Salmon P. Chase himself (in his later capacity as Chief Justice of the Supreme Court) did everyting he could to try and drive out the Greenbacks after the war.

        Was the Confederacy (which produced even more fiat money notes – as well as having a higher and more “Progressive” income tax, and even more government regulations controlling industry and commerce, leading to outright nationalisation of much production and transportation) following an even better policy than the United States?

        On the old (pre Milton Friedman – back in the 1930s) Chicago School:

        I have some sympathy (indeed a lot of sympathy) for an end to credit bubble finance – i.e. for banks lending out real SAVINGS (not book keeping tricks).

        However, “deposit insurance” is an absurdity (one can not properly “insure” against BAD BUSINESS JUDGEMENT) – also I am surprised you bring it up Joe, as deposit “insurance” was not the central point of the old (pre Milton Friedman) Chicago School – ending fractional reserve banking was their main point.

        Government deposit “insurance” already exists (surely you must know that) – and the demand for it exists because of the high risks of FSB (under the old Chicago School there would be no FSB to be insured).

        However, I doubt that any government regulation would work in ending FSB – bankers are just too clever, they would find ways round the regulations (just as they found ways round Peel’s Banking Act of 1844 – credit expansion, and boom-busts continued).

        What would be better would be an END TO ALL GOVERNMENT INTERVENTION.

        No Central Banking (i.e. the drip feed of hidden subsidies to banker antics).

        No ban on “discounting” bank drafts and so on (the ban on “discounting” the paper of the big New York banks was an evil fruit of the Civil War National Banking Acts).

        And no “suspension of cash payments”.

        If a bank can not meet its contractual obligations (in cash) the second they are asked to meet their contractual obligations – then that bank (not matter how big) should go BANKRUPT.

        Fear of going bankrupt might put some limit on banker antics.

        And, of course, an end to “deposit insurance” which gives people a FALSE SENSE OF CONFIDENCE in the banks (and encourages people not to look closely at what the banks are doing).

        Also Joe Bongioanni – YOUR PLAN HAS BEEN TRIED.

        100% reserves in banks – and these reserves not being evil gold, but noble government fiat money.

        It was tried by GENERAL PERON in Argentina.

        The economic policy of General Peron – an end to gold and 100% government fiat money (with banks being under government control with 100% “reserves” of this fiat money) was not exactly a success. in fact it dragged Argentina from a Canadian level of living standards, down into the hyper inflationary Third World.

        Although the Peronists in Argentina claim Peronist economic policy was a success.

        Indeed they claim their present policies are also a success.

        After all they have “low inflation”.

        Which they achive by putting in prison anyone who says that prices are rising faster than the government says they are.

        Very Civil War “Greenbacks” – although the Confederacy (it is often forgotten) put far more people in prison (without proper trial) than Lincoln did (and for “crimes” like questioning paper money).

        Is that the sort of policy you would support?

        Pretend that inflation does not exist – by putting anyone who points it out, in prison?

        After all the American government is already rigging price increase indexes (not that these are a true measure of “inflation” anyway – as inflation, i.e. an increase in the money supply, can occur without any increase in prices in the shops).

        Putting people in prison for rejecting the phony “price indexes” would just be one more step.

        And a government which put people in prison for owning monetary gold (1933 Fascist style economic policy of the Roosevelt regime) can certainly not be trusted not to put people in prison for rejecting phony “price indexes”.

        However, economic law (like the laws of logic and the physical laws of the universe) trumps any government “law”.

        This system will end – and although its end will be terrible, it MUST end.

  • Too much ink.
    Brief reply.

    Whatever Salmon Chase ever thought is irrelevant. The Greenbacks ARE fiat, debt-free money and legal tender – ultimately decided – and they would be again if issued tomorrow.

    And again to be clear, we agree that lending from depositors’ money (full-reserve) is a good idea and that insuring deposits should be unnecessary and is bad for the system.

    The problem with the Peel’s 1844 Act should be obvious – not applicable to demand deposits. So the Chicago Plan and the Kucinich Bill fix all that.

    What I agree on is that we NEED a system where government regulation can be near unnecessary – and having the bankers get back to banking, rather than involved with money-creation, would come close to achieving that goal.

    And you’re right that no regulation can end FRB.
    Only making FRB illegal can accomplish that – which is exactly what the Kucinich Bill does.

    It’s a little comical, if I may, to say that Greenbacks were tried by Peron.
    Greenbacks were tried by US.
    And they worked quite excellently.
    As I said, remaining in existence for over 100 years and NEVER a cent of interest paid for that existence.
    Compare that to 150-year old debt-based money.

    I can’t really comment on putting people in jail for questioning inflation.
    It’s a little too obtuse a concept to grasp.

    Thanks.

  • Paul Marks says:

    What the man who introduced the Greenbacks (and later became Chief Justice of the Supreme Court – arguing that they were unconstitutional) thought of the Greenbacks is “not relevant”.

    That is an astonishing position to take Joe B.

    Well if the Greenbacks are Constitutional (and, I admit, the majority of the Supreme Court in the second Greenback case agreed with you) then so were the CONTINENTALS.

    Joe B. – in your version of history (and of economics) “not worth a Continental” never happened.

    There was no need for a Constitutional Convention – as the Continental Congress could just carry on financing itself by printing Continental fiat money notes.

    No need for Congress may only produce “coin”.

    No need for legal tender only being silver or gold coin in any State.

    One can just carry on printing Continentals – and financing government spending with them.

    General Peron rocks.

    At least he does to you Joe B.

    • What is relevant is what we can do today about the situation in which we find ourselves, today.
      I’m aware of the historic debate, but will not busy myself with what is not relevant to this discussion.

      As you agree, the government’s money-issuing paper is Constitutional and found legal when implemented as was the Greenback.
      That is what is relevant to the discussion about central banking today.

      But, Gee, if you care to discuss the Continental, sure – but only what is relevant.

      The problem is well known of the Continental as the currency of the War and beyond until adoption of the Constitution, etc.
      The problem was counterfeiting by our enemies. Counterfeiting created much more Continental money available than for which there was any need.
      Extra money inflates the price of goods and devalues the currency, causing distrust of the money by the citizenry – which was the exact aim of our enemies.
      During the 17th and 18th centuries, counterfeiting was an oft-used act of war.
      As was done with the French Assignat.
      A read of Chapter 16 of Stephen Zarlenga’s “The Lost Science of Money” – on the REAL differences between government and private issuance of money – would inform on the problems of wartime currency finance, especially Continentals.
      It’s a bit like hacking CB computers these days.

      There is zero acceptance of your notion that Congress can issue only ‘coin’.
      It is “to Coin” the nation’s money.

      The limitation of states to make anything except gold and silver coins legal as tender for debts is not relevant here.
      Having said that, I know of no state that has made anything except the national government’s monies legal tender, (Civil War Excepted) although several efforts are in the can. Whatever they do so, there will be a limitation on both the power declared and the exact medium that is legalized.
      States would be better off following the Byron Dale school of issuing credits for its own use – more like state script – though this is not preferable to the Kucinich Bill, which shares the issuing power WITH the states.

      Thanks.

  • Paul Marks says:

    The policy of hard money was one of the main things that made the United States different from Latin America – not just Argentina under General Peron (who followed Joe B.s monetary and banking ideas to the letter), but many other Latin American regimes.

    Follow the economic policies of the Third World and to the Third World you will go.

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