Bernanke’s Dollar Policy
By MIKE WHITNEY, originally published at CounterPunch
Deflation is not a problem because the Fed can always create inflation by printing more money.
Wrong.
While it’s true that the Fed can print as much money as it chooses, adding to the money stock does not decrease deflation or increase inflation. It merely adds to reserves at the banks. Here’s how British economist John Maynard Keynes summed it up:
"Some people seem to infer from this that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a larger belt. In the United States to-day your belt is plenty big enough for your belly. It is a most misleading thing to stress the quantity of money, which is only a limiting factor, rather than the volume of expenditure, which is the operative factor."
The quantity of money does not matter; what matters is spending ("expenditure"). That’s what creates economic activity and growth. There’s plenty of liquidity in the system right now, in fact, the banks still have nearly $1 trillion in reserves from the last round of quantitative easing, but businesses aren’t investing it in because consumers and households are deeply in debt and unwilling to borrow regardless of the low rates. So loan demand has dried up, money is turning over slower (velocity), and the slump continues. Here’s a clip from a recent post by Reuter’s Felix Salmon that helps to clarify the point:
"…businesses aren’t borrowing or investing — and insofar as they are borrowing, they’re using the proceeds to buy back their stock, rather than to employ more people.
The net result is that the banks — whose collective cost of funds is now less than 1% — are now lending overwhelmingly to just one borrower: (ed–the US gov.)
U.S. banks now own more than $1.5 trillion in Treasuries and taxpayer-backed debt issued by mortgage giants Fannie Mae and Freddie Mac, according to the latest weekly data provided by the Fed. It’s a 30 percent increase from the week prior to the Fed’s Dec. 16, 2008, announcement that it was lowering the main interest rate to 0-0.25 percent.
Outstanding commercial and industrial loans at U.S. banks have fallen from $1.6 trillion in October 2008 to $1.2 trillion this past September, Fed data show. The $390 billion drop is equivalent to a 24 percent reduction in credit to businesses.
It’s truly outrageous that banks are lending more money to the U.S. government than they are to all commercial and industrial borrowers combined…. Bernanke’s monetary policy simply isn’t helping the broad mass of the U.S. population." (America’s failing monetary policy, Felix Salmon, Reuters)
"24 percent reduction in credit to businesses". Loan demand still hasn’t returned to precrisis levels; credit is shrinking and disinflation is edging towards outright deflation. Fed chairman Ben Bernanke crank out more money, but how does he get it to the people who will spend it? Helicopter drops?
It’s a good idea, but that’s fiscal policy which means that it’s congress’s decision, and the new GOP-led congress has already said that they’re going to pinch pennies and cut the deficit, which means it’s a non-starter. So, all Bernanke can do is increase base money, add it to bank reserves, and hope for the best. But don’t expect too much; quantitative easing (QE) may push down long-term interest rates and move a few investors out of Treasuries and into stocks, but it won’t increase demand, narrow the output gap, or lower unemployment in any meaningful way. And, as we’ll see, that’s not Bernanke’s intention anyway.
There’s a lot of confusion about QE, so let’s hear what Bernanke has to say on the topic:
“There’s a sense out there that, quote, quantitative easing, or asset purchases, is some completely foreign, new, strange kind of thing, we have no idea what the hell is going to happen, and it’s an unanticipated and unpredictable policy….Quite the contrary: this is just monetary policy. Monetary policy involves the swapping of assets — essentially, the acquisition of Treasuries and swapping those for other kinds of assets.”
Bernanke’s right. QE merely exchanges Treasuries for reserves or, to put it differently, long-term for short-term debt. (It’s a matter of duration) This changes the composition of the assets on the Fed’s balance sheet and the balance sheets of the banks, but it is not necessarily inflationary. For QE to be inflationary, loan demand has to increase so that more money is borrowed and spent, thus, putting pressure on the price of goods and services. But consumers and households are still digging out from the burst asset bubble which wiped out their home equity, their retirement and much of their savings, so the demand for loans is weak. In other words, the problem cannot be resolved from the supply side; personal debts must be paid-down through an excruciating process of deleveraging that could take years. So, what should fiscal authorities do to keep the economy on track and avoid a protracted period of subpar performance?
That’s easy, because the preferred method for easing the effects of recession for the last 80 years has been varying doses of "Keynesian" fiscal stimulus. This is not some new-fangled theory; it is settled science like evolution. Unfortunately, the GOP-led "pain caucus" in congress want to implement austerity measures that will deepen the downturn and increase unemployment. It’s the economic equivalent of creationism.
Here’s how Keynes summed it up in an article titled "An Open Letter to President Roosevelt":
"The object of recovery is to increase the national output and put more men to work. In the economic system of the modern world, output is primarily produced for sale; and the volume of output depends on the amount of purchasing power… Broadly speaking, therefore, an increase of output cannot occur unless by the operation of one or other of three factors. Individuals must be induced to spend more out of their existing incomes; or the business world must be induced, either by increased confidence in the prospects or by a lower rate of interest, to create additional current incomes in the hands of their employees, which is what happens when either the working or the fixed capital of the country is being increased; or public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money. In bad times the first factor cannot be expected to work on a sufficient scale. The second factor will come in as the second wave of attack on the slump after the tide has been turned by the expenditures of public authority. It is, therefore, only from the third factor that we can expect the initial major impulse. …
Thus as the prime mover in the first stage of the technique of recovery I lay overwhelming emphasis on the increase of national purchasing power resulting from governmental expenditure which is financed by Loans and not by taxing present incomes. Nothing else counts in comparison with this."
So, when consumers cannot spend (because they are underwater on their mortgages, credit cards etc), and businesses won’t spend because there are no profitable outlets for investment, then the government must spend (by increasing its budget deficits) or the economy will plunge back into recession.
But rather than follow the tried-and-true method of Keynes, Bernanke has pinned his hopes on QE, which merely adds to bank reserves, lowers long-term interest rates and angers trading partners who’ve seen capital flee the US for better returns in their markets. This is backasswards way of addressing a rather straightforward problem; lack of aggregate demand. Oddly enough, Bernanke knows that his policy won’t work because he did extensive research on Japan’s Lost Decade and recommended coordination between monetary and fiscal authorities to end deflation. QE was tried repeatedly in Japan and failed. Here’s an excerpt from a report from the Bank for International Settlements (BIS) which appeared in a post by Pragmatic Capitalist:
“A striking recent illustration of the tenuous link between excess reserves and bank lending is the experience during the Bank of Japan’s “quantitative easing” policy in 2001-2006. Despite significant expansions in excess reserve balances, and the associated increase in base money, during the zero-interest rate policy, lending in the Japanese banking system did not increase robustly.”
Monetary policy alone will not lead to a recovery, and Bernanke knows it. QE has more to do with politics than economics.
Here’s how Nomura’s chief economist Richard Koo described QE:
“The central bank’s implementation of QE at a time of zero interest rates was similar to a shopkeeper who, unable to sell more than 100 apples a day at $100 each, tries stocking the shelves with 1,000 apples, and when that has no effect, adds another 1,000. As long as the price remains the same, there is no reason consumer behavior should change–sales will remain stuck at about 100 even if the shopkeeper puts 3,000 apples on display. This is essentially the story of QE, which not only failed to bring about economic recovery, but also failed to stop asset prices from falling well into 2003.” ("Quantitative Easing; "The greatest monetary non event", Pragmatic Capitalist)
Read that last part over again: "but also failed to stop asset prices from falling well into 2003.” Wall Street has been swept up in the QE-hype thinking that "If the Fed is printing, stocks are going to soar!" Wrong. Equities surged more than 200 points on Thursday, but then quickly fell to earth the next day. QE might create some "froth" in asset prices for a while, but it won’t keep stocks airborne indefinitely nor will it boost inflation to the Fed’s target rate of 2%. Also, if two years of zero rates haven’t increased demand and put the economy back on track, then how are a few blips slashed from long-term interest rates going to help? It won’t. The Fed is just nipping at the edges.
So, what happens now? What happens when rates are already at zero and final demand continues to shrink as it is presently? Last Friday’s report from the Bureau of Economic Analysis (BEA) shows that final demand slipped to 0.6% and is trending downward. How can Bernanke stimulate spending (and boost demand) if his main policy tool (interest rates) no longer works? That’s the question, and that’s why he’s resorting to unconventional strategies like QE.
Bernanke needs to weaken the dollar to kickstart the economy, but his effort is rankling trading partners who have been recycling the proceeds from their exports into US Treasuries to keep the dollar artificially high. The sudden policy reversal has also left retirees in the United States worried that their savings are about to take another hit as Bernanke engages in an exchange rate conflagration that could end in a wave of protectionism and sharp decline in the dollar.
The plan to trash the dollar is not a unilateral gambit by Bernanke either. The entire Washington establishment—including the White House—appears to be behind it. In Saturday’s New York Times, President Barack Obama made the case for devaluation in predictable Orwellian doublespeak. Here’s an excerpt from the op-ed eerily titled "Exporting Our Way to Stability":
"As the United States recovers from this recession, the biggest mistake we could make would be to rebuild our economy on the same pile of debt or the paper profits of financial speculation. We need to rebuild on a new, stronger foundation for economic growth. And part of that foundation involves doing what Americans have always done best: discovering, creating and building products that are sold all over the world.
We want to be known not just for what we consume, but for what we produce. And the more we export abroad, the more jobs we create in America. In fact, every $1 billion we export supports more than 5,000 jobs at home.
It is for this reason that I set a goal of doubling America’s exports in the next five years. To do that, we need to find new customers in new markets for American-made goods. And some of the fastest-growing markets in the world are in Asia, where I’m traveling this week." (Barack Obama, NY Times)
The only way the US can double exports in 5 years is by reducing the dollar to fishwrap—which appears to be the policy.
