There’s no doubt that the big question for markets this week and next is whether Bernanke will crank up the printing-press and purchase more US debt, in a so-called QE3. And from my point of view the answer is very easy: yes, he will. Bernanke’s academic career is characterised by him publishing papers on novel ways for government to stimulate the economy. And while he didn’t directly announce a program of easing, he did extend the next Fed policy meeting to two days, possibly to build consensus on the tools and the exact methodology that will be deployed. And with “highly-influential” investment bank Goldman Sachs foreseeing a program of great easing going into 2012 who am I to disagree?
Of course, there is a political dimension to this, too. Washington has taken on a rather hawkish austerity mood. Rick Perry — crony capitalist, philistine and stimulus recipient — recently said that people in Texas would “treat Bernanke pretty ugly” if he printed any more money before the 2012 election, as that would be “playing politics“. Some Fed governors are increasingly hostile to an easing program that they see as having had few or no positive effects. But the real political issue is that of bondholders — particularly the Chinese and Russian governments — becoming increasingly tepid at the prospect of what they see as greater devaluation. So it is no surprise to me at all that Bernanke’s approach is characterised by subtlety, caution and consensus building, even if the academic Bernanke once told Japan to show some “Rooseveltian resolve” on very much the same issue. Of course, none of these signs is enough for arch-Keynesian agitator Paul Krugman:
John Maynard Keynes:
“But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.”
“These are tempestuous times, but when the storm is long past the ocean will be flat again.”
There is one thing that pollicy makers can do to get the money flowing more easily: in 2008 the Fed took the decision to pay interest on excess bank reserves. This was ostensibly to prevent banks from running into leverage woes: the more reserves they held, the less likely they were to go bankrupt. But look at what has happened since the Fed took that decision:
That’s right: hoarding cash. If Bernanke wants to focus on getting cash flowing, they should stop paying interest on excess reserves. All it is doing is raising net real rates, which are clearly still high enough (even with the zero-interest rate policy, and all of the QE) to make cash and low-interest bonds attractive to risk-averse, cash-rich institutional investors, and banks. Of course, unleashing all those excess reserves might have a huge inflationary impact.
But back to Krugman — there are two models of thought here: Krugman believes that the problem is a negative demand shock fuelling a liquidity trap, and that the only way out is to pump what he calculates to be a sufficient level of stimulus. He believes this extra spending will get money circulating, banks lending, and people investing again. The other model of thought — as proposed by Thomas Hoenig, and myself, among others — is that no amount of stimulus would be sufficient, as the underlying problems are structural. On the 25th of August I wrote:
Those troubles are non-monetary — they are systemic and infrastructural: military overspending, political corruption, public and private indebtedness, withering infrastructure, oil dependence, deindustrialisation, bailout culture, systemic fragility, and so forth
As an investor, why would you choose not to invest money? Is it likely to be because even with a zero-interest rate policy, the Fed not printing enough money, and government spending is not high enough? Or is it more likely to be because of deeper infrastructural, socio-political and geostrategic factors? The death of the dollar as the world’s reserve currency, the rise of China, the potential for an oil shock, etc? In my view, no amount of stimulus or easing can make the real problems go away — all they do is massage the situation a little, and buy time for policy makers to fix the real problems.
So, as much as I believe Krugman is wrong, clearly, we do need to test Krugman’s calculation. Otherwise he (and his intellectual descendants) will just yak on and on about how he was right. So — isn’t it time Obama ditched Geithner and offered the job of Treasury Secretary ’til the end of 2012 — and a blank stimulus cheque — to Paul Krugman? After all, we would get a definitive answer as to whether or not the problems are structural — as I believe — or soluble by stimulus, as Krugman believes.