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November 21, 2014


I just blogged an essay in which I approved of the Fed’s $4 trillion purchase of treasury bonds and mortgage-backed securities with depression staring us in the face, but that doesn’t mean I approve of the ways the recipients of the Fed’s largesse utilized their unexpected troves. Critics of the Fed’s bond-buying (QE) program when it first started warned of disasters such as runaway inflation, a surge in unemployment, a weak dollar, market bubbles etc., and as I pointed out in my recent essay on the QE program which started almost exactly six years ago, none of this happened. The politicians were having a field day in announcing that QE would bring our economy to its knees (it was one of “them” socialist Keynesian tactics, you know). Our dollar is instead strong and inflation is weak. Keynesian intervention in the market worked, as usual, though it would have worked better and faster if corporate America and the Wall Street banks had not played the Fed and the rest of us for suckers.

A propped-up bond market plus the Fed’s historic reduction in borrowing rates were designed, among other things, to put cheap money into the hands of corporate America so that business would have the capital to pep up the economy with new and increased spending for plant, increased employment and the like, thereby not only saving our economy from recession but giving it the wherewithal to expand as well. The problem in this connection is that the Fed can only hand out money; it cannot set policy and has no mechanism for enforcement for the way in which it will be spent. The Fed can only hope that recipients of its multi-trillion dollar purchases will concretely follow the rationale of the Fed’s stated purposes in having the program at all. Policy is thus not within the congressionally-set portfolio mandated to the Fed; it rather remains the preserve of Congress.

As an independent agency, the Fed sets interest rates with an eye on inflation and unemployment and economic growth numbers, but it is a toothless tiger with respect to enforcement. Its $4 trillion dollar Keynesian adventure is all the more amazing as a positive initiative given that its enforcement powers are extremely limited. It was a venture into the unknown of hope and faith that corporate America and Wall Street banks would use the money to do what was good for America. They didn’t, as will be seen.

So now to my objection to the QE not set forth in my preceding essay – Corporate America and Wall Street banks did not spend the money lavished on their balance sheets by the Fed for the purposes outlined by the Fed. Corporate America and Wall Street banks instead helped prolong the recovery (still in malaise) by seeing that much of such money never saw daylight. They just sat on it, and the Fed had no policy-making or enforcement powers to make them spend the money on and for the purposes outlined by the Fed in commencing the program. Worse, the Fed paid interest on those reserves, which provided income to the banks for doing nothing with money that was literally given to them, all of which provided scant incentive to the banks to “invest in new plant and production facilities” etc. Why should they? Why would you take on risk in a moribund economy when you are making money off the money gifted to you within a scenario that the donor has no enforcement power over how the donee spends or doesn’t spend the money?

As an administrative matter, when the Fed bought bonds from big Wall Street banks, it gave them an electronic credit on their accounts at the Fed. Result, and proof that the banks did little to help our economy out of its doldrums by putting their money to work? Excess bank reserves soared from $800 billion at the start of 2009 to $2.7 trillion today! When looking over the conduct of the big Wall Street banks in this connection (not to mention almost daily recitations of their criminal and near-criminal activities), the term “obscene” comes to mind.

The real problem, of course, is that those who are giving away money have no way to impose conditions on the donee corporations and banks on how and for what it must be spent. Such spending should be done by those with the money AND the authority to dictate how and for what it is to be spent, but can anybody reading this even imagine a scene in which Obama requested $4 trillion from a Keynesian-hating House and a filibustering Senate? Speaking of terms, I would expect to see and hear the term “insanity” generously applied by politicians and press to such a scene.

I could discuss a number of problems created and problems solved that have arisen in our economy resulting from the Fed’s brave adoption and implementation of QE1 through QE3, but one such problem is both salient and delicate and it is this: How is the Fed going to sell such a massive collection of bonds without disrupting markets? The Fed’s answer? Very, very slowly. The Fed has promised that it will stop reinvesting money from bonds when they mature, whittling away the bonds in a “gradual and predictable manner.” Our central banker (the Fed) appears to correctly understand how unloading its trillions in bonds on the market could have dramatic effects on our financial system, effects that no one can predict, and have properly assured us that they will be sensitive to market conditions as they sell off such assets in coming years.

Liz Ann Sonders, chief investment strategist at Charles Schwab, correctly points out that economists usually can find similar situations in the past and use them to guide projections, but that history offers little guidance for the months ahead, noting further that the Fed has never before wrapped up a $4 trillion stimulus program and has no experience in raising interest rates from zero. She says that “Usually you can ask, ‘When’s the last time the Fed did this?’” “But, no, there is no last time” (this essay’s title).

We are thus in uncharted economic territory. The Fed has told us that interest rates are going to go up and economists are already worrying that unless rates go up gradually we will derail the recovery. Others fear that if rates don’t go up fast enough inflation will take off. The beat goes on, and on. . .

So where are we? Was QE a success or failure, or does the answer to that depend on whether our particular interests were served? Dean Baker of the liberal think tank Economic and Policy Research came up with a Solomon-like answer to that question with his statement that “The criticisms of QE were clearly overblown (but) the flip side is that the benefits were exaggerated, too.”

My take on this ultimate issue is that while it was clearly the right thing to do with deflation staring us in the face during Bush’s Great Recession, it is too early to tell how it is going to wash out in the long haul given that our recovery is anything but robust and that we have never been down this road before. With all the uncertainties aggravated by our adoption of deflationary austerity as policy, I can only come up with an even feebler response than the one given by Baker (above), and it is this: We’ll see.   GERALD    E


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