Baruch received old media brickbats for his bloggy frettings last year about the impact and meaning of QE2. At the time, while understanding why people thought it was necessary, he worried that we were opening a can of worms which were going to wriggle off in all sorts of undesirable directions. He wrote:
in his darker moments that Baruch thinks a very good analogy for where we are right now is Pet Sematary. The people who buried their cat (and later their son) in the Indian burial ground to bring it back to life got something which looked ostensibly like a cat, but was so only on the outside. On the inside their little puddy tat was really an undead homicidal zombie cat, as became clear through its increasingly odd behaviour. Unintended consequences followed (mayhem, murder, horror, the Wendigo — all that Stephen King stuff).
The Bernank is like the guy who buried his cat, but in this case instead of a resuscitated cat he wanted his rally back, a healthy stock market and the wealth effect that would bring. I worry we have got something else.
Pointing to potentially horrible unknown unknowns tends to capture the imagination much less than pointing to the definitely unpleasant known knowns of an imminent economic slowdown. The QE2ers’ argument at its core was the eternal and seductive call that Something Must Be Done. No less than James Suroweicki at the New Yorker picked up Baruch’s idea of the “undead homicidal zombie market”, tautology and all, and lumping me in with the Tea Partiers, House Republicans and the other dead-end no-brained foes of QE, labelled us “hysterical”. Baruch loves the New Yorker, but knowing their editorial stance and lack of track record when it comes to advising macro funds and governments, Baruch concluded their love of QE was less a well-thought-out economic analysis, and more a gleeful response to finding their political foes against an idea that felt “right”, Colbert-like, in their gut. In his response, (Felix also had a good one) Baruch bemoaned the politicisation of monetary policy by anyone. This hasn’t got any better – having an (admittedly Texan) presidential candidate threatening the Chairman of the Federal Reserve with a tarrin’ and a featherin’ if he buys any more bonds doesn’t seem conducive to a mature conversation on the subject.
So, was Baruch right? Or were the Suroweickians? An interesting thought experiment would be to think of where we would be without that second round of easing. With the benefit of hindsight I’m inclined to think we would have been better off right now had we not done QE2. Why?
- back then, when the decision to ease was taken, we were clearly heading for an imminent global recession, which we didn’t have. However, we are undeniably there again, except we are also likely to have it accompanied by a sovereign credit crisis. It’s unlikely that counterfactual recession, had it taken place, would have been the short, sharp, devastating shock we got in 2008-2009 – the “V” shape; rather it would likely have been a more considered, drawn out process — a “U” shape — which would eventually have led to some sort of natural bottom. Whether we would be at that bottom now, 1 year later, is debatable. But we would certainly be closer to it, as opposed to now, just about to start our tribulations, with the blessed relief of the inevitable upswing much farther ahead of us and all the pain still to come.
- without QE2 we would have higher US unemployment right now, and an increase in the numbers of long term unemployed, a great evil. This is true. But we can’t say we have avoided this outcome either, merely postponed it. More than that, as I argue below, by QE2-ing prematurely we have much less room to respond to future, unemployment-creating shocks, making more long term unemployment more likely.
- we were heading into a proper bear market in stocks and a bull market in bonds when QE2 was initiated. Without it, we would not have had the rally in stocks in late 2010 and early 2011. The lower wealth effect would have intensified the fall into recession. However, again, this is likely still to come. Frankly I would have preferred this to be behind us, too. Also, by creating apparent demand that wasn’t real QE2 may have made any fundamental correction more painful by adding a further inventory component.
A fair criticism at this point would be that, fine, quantitative easing doesn’t appear to have worked, but it might have. It did no harm that would not have happened anyway, and postponing it was worthwhile enough; who knows, something could have happened. Given the imminent economic danger, it was worth a try, and as Suroweicki wrote at the time, it looked like “doing nothing would be doing damage.” In retrospect, however, it looks like there have been 2 important negative outcomes of QE2, one an “intended” consequence, or at least a cost that was clear at the time, the other a consequence that was definitely unintended.
What was clear back then is that the Fed was going to be firing all its ammo — or to mix my metaphors, after QE2 it was going to have a lot less room for manoeuvre. Even if we are going to get QE3 we probably need a decent interval before we can do so, if only to maintain the figleaf that QE is not a permanent condition for the West having an apparently normal (read “zombie”) economy. In that interval a lot of bad stuff can happen, and the remaining unconventional tools the Fed still has in its box are looking, frankly, more Pythonesque than anything else; Operation Twist has apparently been tried before, (HT Kid Dynamite via AR) and didn’t work then, either.
I haven’t heard anyone use the words “money illusion” in a long time. I don’t know why that is, but I fear it is my age; that concept used to be a staple of my macro economics classes in the early 1990s, the then-consensus being from data in the 1970s and 1980s that while there may be some money illusion (“oh look there’s an extra zero on my paycheck dear, let’s buy that new LCD TV”) at the start of a period of expansionary monetary policy, over time it fades and the policy loses traction. We weren’t all Keynsians then. My fear is that the inevitable short term lift to the market from future QEs will be a disappointment. As far as QE2 went, it may have been better to wait — pump priming is best when there is actual water in the well. When it is draining out of the bottom, you’re just throwing what you had left away.
The second, less intended, and more insidious consequence of this great experiment, is that QE2 may have had an impact on the one part of the global economy that didn’t need saving: China. Baruch isn’t sure he understands exactly how Chinese monetary policy works (and neither is anyone else, it seems, which is why it has been under-reported), but something happened recently with capital requirements for Chinese banks that seems to be biting harder than that which has gone before. Baruch spends a lot of time with his ear to the ground on what happens to his stocks in China, and there’s been some funny checks of late — lower PC sales to businesses, sales of air conditioners not being what they were, etc, all apparently driven by a widespread inability to secure finance. The argument here is that QE spiked nominal commodity prices and made what was already a problem in China, high domestic inflation, significantly worse, turning it into people’s enemy number one. Baruch has little time for China bears and reckons economic growth there is real and good. So he would be very disappointed were there to be a hiccup or worse in China as a result of a failed round of QE. The only consolation is that there’s likely to be so much fucked up shit going in Europe when it does happen that we’re likely not to notice.
With hindsight then, the balance of the ledger doesn’t look good for the QE2ers and Suroweicki; it looks like we merely postponed a double dip, so that it lies in our future not in our past, and made sure there is much less US monetary policy can do to help when the time comes that the economy may actually be susceptible to unconventional easing. More than that, we may have screwed the only part of the global economy which was capable of hauling us out of our problems the old fashioned way, by real wealth creation. How’s that for “hysterical”?