Summary: We live in an age of wonders, in which things unforeseen — even unimagined — become daily fare for the news, or remain unremarked. This is the second chapter in this series, attempting to open your eyes to the amazing things taking place. Today we have a guest post by Nathan Lewis looking at the monetary madness that slowly infects the major nations, as we confuse the ability to print money with magic.
- To QE4, and beyond!
- About the author
- Other articles about our monetary future
- For More Information
The major nations responded to the great recession with conventional monetary stimulus (in addition to other measures). As it deepened, these were expanded — along with extensive guarantees of securities (especially those of banks and governments). Governments then turned to unconventional measures as the long slowdown continued. As years passed and a self-sustaining recovery remained out of reach, bolder measures appear desirable. Measures seldom attempted, never with success, often with horrific endings.
What’s next in this fantastic story? Here we have a guest post by Nathan Lewis that explains the amazing monetary history of 21st century America, which — depending on how long we stay on this path — might earn us a place in the history books along with the Mississippi Bubble and other incidents of monetary magic.
(2) To QE4, and beyond!
Excerpt from the Q4 2012 Letter of Kiku Partners
by Nathan Lewis
Part 1 of 2.
“QE4” refers to the decision by the Federal Reserve in December to continue the $45 billion per month of long-maturity U.S. Treasury bond purchases after the completion of “Operation Twist” in January. “Operation Twist” was the selling of short-dated bonds and purchases of long-dated bonds, which did not involve a net increase in assets, or a net increase in money creation to pay for those assets. In central-banker terminology, it was “sterilized.” Now that the Fed has run out of short-term assets to sell, to continue its purchases it must turn to the printing press. This produces a considerable increase in total money creation, which was already scheduled to go higher with the introduction of “QE3” in September, the purchase of $40 billion per month of mortage-backed securities (MBS) securities with an open-ended timeframe. Thus, the total monthly money-printing agenda rises to $85 billion per month, which, to my mind, deserves its own integer in our evolving QE nomenclature.
QE4 is also apparently open-ended, although there was mention of unemployment and inflation thresholds. Nothing is forever, but I am guessing that both QE3 and QE4 will continue throughout 2013, and possibly be increased further. For now, the talk is of the Fed backing off perhaps in mid-2013, but I sense that we have gone beyond what I have called the Keynesian justifications for QE, and are now deep into what amounts to direct government finance, or, at least, the goal of keeping long-term Treasury yields at artificial lows, which is effectively the same thing although it has something of a Keynesian aroma.
Here is a graph of the U.S. dollar monetary base, assuming $85 billion per month increase from January:
The fact that the Fed’s money-printing schedule is roughly in line with the Treasury’s expected net debt issuance is lost on no-one. Actually, Operation Twist ($45B/month) resulted in the Fed buying the equivalent of 91% of the Treasury’s gross long-term debt issuance (including rollovers). In 2013, the Fed is expected to buy the equivalent of 90% of all net debt issuance from all sources – which is of course concentrated in Treasury’s, MBS, student loans and other agency-type stuff, since the private-sector fixed-income world is contracting.
The “QE4-ever” impression is strengthened by the outcome of the “fiscal cliff” discussions at the end of 2012. To nobody’s great surprise, the status quo was maintained in basically unchanged form. Spending cuts essentially disappeared. The preexisting tax situation was also more-or-less maintained, although with a meaningful trend toward higher taxes, not only in the form of income taxes on higher incomes but also the end of the “temporary” payroll tax cut.
I see a tendency toward deterioration in the U.S. economy, following similar deterioration in Europe and Japan where new recessions have been officially declared. Perhaps, as some of our more talented economy-watchers have asserted, a new U.S. recession has already begun. This existing tendency will, if anything, be worsened by the tax increases resulting from the “fiscal cliff” outcome. Whether “slowdown” or “recession” or even, in pure denial, “recovery” is the official story, the outcome is likely to be greater government spending and less tax revenue, which comes on top of larger secular trends (boomer retirement and entitlement bloat) producing the same outcome. In other words, big deficits continue in the U.S.
The Debt Ceiling
The debt ceiling has always been a rather clumsy and irrational apparatus, but it has produced an opportunity for the U.S. political system to have an important discussion about fiscal trends – especially now that we seem to have fallen out of the habit of having a Federal budget. In mid-2011, the debt ceiling debates produced quite a lot of political movement, much of it positive in the sense that serious and meaningful proposals were put forth – proposals which resulted in the “fiscal cliff” among other things. At least, the 2011 debates seem sober and meaningful today. At the time, foreign observers generally said that they were appalled that the United States political system was going into ineffective convulsions over the deficit issue.
Today, the fashion seems to be to ignore the debt ceiling issue, and perhaps make it go away by eliminating the debt ceiling provision altogether. The political system is deciding that maybe it doesn’t want to have a debate on the topic after all, which suggests that no solutions will be forthcoming either. Some Republicans make threats of “shutting down the government,” similar to what was done in 1995-6. A problem today is that, ironically, the deficit is so large that it would simply be too disruptive to contemplate. So, Republicans will most likely cave in the end. I suppose it is mostly an exercise in blame-avoidance.
QE4 as the same old, same old
Historically, the Federal Reserve has always been called upon to help finance the Federal government when deficits have been large. Previously, this was the case in World War I and World War II. In both cases, the rubric was couched in terms of interest rates. The Fed would “control” interest rates, allowing the government to sell debt at low yields. This “controlling” of interest rates involved money printing and bond-buying. In both cases, money was printed and the dollar lost value as a result.
These episodes were rather short, just a few years – reflecting the fact that U.S. involvement in both European wars was itself only a year or so long. After the wars ended, the Federal government soon ran a surplus, and thus did not issue any more debt. The Fed was thus off the hook for assisting in the issuance of debt, and could return its focus to properly managing the currency, which in those days meant a gold standard parity. This was the case in 1920-1921, and again after the Fed Accord of 1951.
The Fed was pressured by the Treasury to help finance deficits related to World War I. This resulted
in a large expansion in the monetary base, which continued until the war ended and deficits ceased.
Even before the Federal Reserve existed, this pattern was present during the Civil War, the War of 1812, the Revolutionary War, and indeed in various colonial government money-printing episodes dating back to the beginning of the 18th century. The Fed was pressured by the Treasury to help finance deficits related to World War I. This resulted in a large expansion in the monetary base, which continued until the war ended and deficits ceased. The same thing happened in World War II.
Today and Tomorrow
Different this time it is not. Again the Fed is trying to “control” long-term interest rates, thus facilitating Federal government deficit financing. This is couched in Keynesian terms today, but it is functionally no different than 1918 or 1945 in my view. However, unlike those times, there is little prospect for surpluses to appear or even for deficits to shrink by any meaningful amount.
Admittedly, it is possible that tax revenues, as a percentage of GDP, will rise from their historically depressed levels, which could reduce the deficit considerably. This would likely coincide with a genuine economic boom, which does not seem probable to me.
Thus, in practice, I suspect that the Fed will be locked in to its present money-printing/bond-buying role for some time, which implies to me that QE efforts will be maintained at the present pace or accelerate, with whatever justifications this requires issued at appropriate intervals along the way. The justifications will seem plausible at the time, because they will try very hard to make them so.
Stay tuned for part 2, lookign at our future, based on experiences of other nations who have taken this path.
(3) About the author
Nathan Lewis is the principal of Kiku Capital Management LLC, which manages a private investment partnership. He was formerly the Chief International Economist and Global Strategist for firms providing investment research to institutions. His book Gold: the Once and Future Money was published by Agora Book Publishing and John Wiley in 2007, and is now available in five languages.He has written for the Financial Times, Huffington Post, Nikkei Business, Daily Reckoning, Japan Times, Daily Yomiuri, Pravda, Asian Wall Street Journal, Dow Jones Newswires, Worth, and other publications. He has a weekly column at Forbes.com. His website is: New Worlde Economics.
He has spoken before audiences at the Heritage Foundation, New York Society of Securities Analysts, Utah Gold Money Summit, and other venues. In August 2012, he testified before the House subcommittee on Domestic Monetary Policy on the topic of “parallel currencies.”
Here is a series by Lewis at The Huffington Post, explaining the hidden workings of our financial system, using Goldman Sachs as the lens. I recommend reading them.
- Do We Need Goldman Sachs?
- The GS-Files 2: Stuffing the Taxpayer
- The GS-Files 3: Heads We Win, Tails You Lose
- The GS-Files 4: Always a Winner
Other posts here by Nathan Lewis:
- A parable of America today – subways here and around the world, 5 January 2010
- About urban farming: impractical romanticism for a lost age, 23 April 2010
(4) Other articles about our monetary future
(a) A look at the next big step towards radical new monetary worlds
“A breakthrough speech on monetary policy“, Anatole Kaletsky, Reuters, 7 February 2013 — Analysis of “Debt, Money and Mephistopheles: How Do We Get Out of This Mess?“, Adair Turner, 6 February 2013 — Turner is chairman of Britain’s Financial Services Authority and one of the most influential financial policymakers in the world. Kaletsky calls this a “truly historic speech”.
(b) Satire today, but tomorrow?
“QE Cubed: A Modest Proposal for More Fed Buying. A Lot More“, David Kemper, BusinessWeek, 1 February 2013 — Kemper is Chairman and CEO of Commerce Bancshares, and past President of the Federal Advisory Council of the Federal Reserve. Full bio here. Money paragraph:
That is why I propose the Federal Open Market Committee’s next move be to take our central bank to a whole new level — a 2013 campaign that I call QE Cubed. Why not expand the Fed balance sheet exponentially, from its current $3 trillion to $33 trillion? Earning an extra 3 percent on another $30 trillion in bonds would allow the Fed to return an additional $900 billion to the Treasury—thus wiping out most of our federal deficit while avoiding actually having to do anything about current government spending.
(5) For More Information
- The Fed is not wildly printing money, as yet no hyperinflation, we’re not becoming Zimbabwe, 2 March 2010
- Important things to know about QE2 (forewarned is forearmed), 21 October 2010
- Bernanke leads us down the hole to wonderland! (more about QE2), 5 November 2010
- Inflation is coming! Inflation is coming!, 7 February 2011
- Inciting fear of inflation in our minds for political gain (we are easily led), 28 February 2011
- Update on the inflation hysteria, the invisible monster about to devour us!. 15 April 2011
- Explaining the gold standard, the Euro, Default, Deflation, and Hyperinflation, 17 December 2011
- What every American needs to know about the Federal Reserve System, 31 March 2012
- What are the limitations of the Fed’s power? It’s neither impotent nor omnipotent!, 17 February 2012
- The lost history of money, an antidote to the myths, 1 December 2012