Saturday, February 4, 2012

- The Case For More QE

QE (quantitative easing) does not cause inflation. This is a fact. We’ve had a ton of QE ourselves - over a trillion dollars worth, and inflation continues to be quite low. The Japanese have had two decades of QE, with little or no inflation to speak of in any of that time. So it’s a hard and fast fact that QE does not cause inflation. We need economic growth to get real inflation, and until we get it we won’t see any, QE or no QE.

But what QE does do is make the onset of inflation much more likely. And when that inflation does begin, its rate of increase will be much higher than it would be with a smaller monetary base. Inflation comes like Hamlet’s sorrow, “not in single spies but in battalions”. It always arrives suddenly, and increases rapidly. And with a larger monetary base, it will go from 2% to 10% in the time it might have taken to go from 2% to 3%. This is what makes QE so dangerous.

How high the level of inflation will rise will be a function of how we react when it first pokes up its head. If the first signs of inflation are greeted with aggressive increases in interest rates, then it’s possible to not have runaway inflation at all – no matter what your monetary base. But raising rates is tough politically, and raising them a lot is even tougher. So with lots of QE around, it’s likely that we’ll end up with more inflation than we like, simply because we can’t do what we must, even if we know we have to.

In spite of what you may hear in the more populist circles, Ben Bernanke is not stupid. He’s not trying to destroy America. I don’t believe he’s after any more power than he currently has or that he cares about using his position to increase his personal wealth. At least – there is nothing in his behavior that would lead a rational man to believe so. But what I think he really wants is what many men in his position want. I think he wants to be the hero. I think he wants to be the guy who saved America from the “second great depression.” I think he’s worried about his intellectual legacy.

You may not like this, but with the way our system is currently designed, that’s exactly what he’s supposed to be worried about. His vanity is supposed to drive him toward making the right decision for the good of the country, even if it’s politically unpopular. Our political system has a very short term (one election) view. But the Fed is independent in order to encourage the chairman and the board to do what they know what’s right in spite of that. The current system is designed to encourage them to remain above the political fray and to do what history will most revere them for.

In that context, I think Bernanke is doing OK. There is a perfectly valid intellectual debate about what specifically he’s doing, and opinions will differ. But I don’t think there is anyone out there who understands the process, who believes that he’s that far out of line. He’s taking what amounts to the conventional economic wisdom – right or wrong – and doing his best to implement a plan which reflects that. Men fail all the time. But I don't think you can reasonably make the argument that he isn't trying his best.

We’ve seen a big uptick in payroll numbers – a substantial portion of which is a result of technical adjustments to the number. Bernanke knows that as well as anyone, so I don’t think the current ‘good news’ about unemployment will change his plans much. I think we will continue to see more QE – and that economic growth will be mitigated by increased input costs. This will keep the overall growth level low. That may sound bad, or at least worse than rapid growth. But it has the upside of preventing the fiscal bankruptcy of the nation that would come from rapidly increased interest cost.

In effect, I think QE with all its negative consequences, is really just buying us time. In the autumn we will likely get a more responsible congress and a change of administrations in the Whitehouse. We can then begin to dismantle some of the bureaucratic cholesterol that’s clogging the nation’s economic veins and putting the country on a more fiscally sustainable path. Until then, QE will keep the patient alive. It’s like an artificially induced coma, designed to give us enough time to heal. It’s dangerous, but I think it’s less dangerous than the alternative.


chess johns said...

tom. im new to you over the past month. please keep em coming.... if the the unemployment numbers continue to improve i doubt we can take the whitehouse but please dont give me nancy back. please.

Rick Bomstein said...


I get your point, but you absolutely do not need economic growth to get inflation--just look at Weimar Germany, Argentina, Zimbabwe, or even the US and UK in the 1970s. Printing more money by definition makes existing currency worth less (or eventually...worthless) - the only question is how quickly and against what...


Tom said...


you need to be careful in economics whenever you need to include the term 'eventually'. You'd be amazed how long the (absolutely inevitable) negative consequences of an act can be put off. I know I always am.

You should think of inflation as too much money chasing too little stuff. The thing that makes the amount of stuff you have accurately described as 'too little' in this environment is growth. It may be a different story if the Chinese bomb our excess productive capacity to smithereens, or if we deport all the people who know how to work the milling machines and lathes. Or even if we ship our hard assets overseas to be sold and the proceeds dumped into the politicians Swiss bank accounts.

But those circumstances aren't very likely - nowhere near as likely as vigorous economic growth.

It's not as linear in real life as it is on paper.

Rick Bomstein said...


Again, gotta disagree - inflation is all about too much $, the "too little stuff" part of the argument just has to do with what it depreciates against. In fact, I would argue we've had tremendous inflation over the past decade or so, it's just been in financial assets, real estate and commodities rather than in finished goods (and there's almost certainly been more there than the CPI tells us...) I've always found it more useful to view "inflation" as the currency depreciating against something, rather than the other way around--rising prices are simply a symptom of the underlying disease.

Also, re: growth, as you well know this country is nowhere near as welcoming to capital as it used to be...

The problem with fiat currencies is they're all essentially faith-based, since there's no intrinsic value and supply is theoretically unlimited. My guess is that the collapse of paper currencies will come about similar to the way Fitzgerald described going broke - slowly, then all at once...

Hell_Is_Like_Newark said...


I can tell you a lot of US $$ have been converted to oil. That oil is sitting in tank farms, defunct tankers used as floating storage, and salt domes. The price of oil in no way reflects current demand and supply, the latter of which has been increasing. Domestic demand has dropped so much that we are exporting refined petroleum products, something we haven't done on this scale since pre WWII.

So what happens when that oil is no longer kept on the market (oil converted back to dollars). Will we see a price crash in oil and a price increase for everything else?


Say we do get growth, velocity of money picks up, and we start getting 1970's style inflation... what are the options for the Fed to defend the dollar without throwing the economy back into recession?

Tom said...

Why would they want to 'defend' the dollar? This administration is under the thrall of the unions, and the unions all believe that a weak dollar will increase exports - supporting manufacturing jobs.

Sorry, after that idiotic OpEd piece in the Times today on taxing unrealized gains, I'm feeling like we'd all be better off letting them burn it all down and starting from scratch. I'm not so horrified that some idiot came up with the idea, but I am horrified that it's being taken seriously.

Some days... you feel like there just isn't a point in arguing.

Hell_Is_Like_Newark said...

Tom... Seriously?

That is the dumbest idea I have heard since NJ instituted an alternative minimum business tax, which was based on revenues, not profits.