hu jintao

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QE ∞

The Keynesians and Monetarists who have so berated the Federal Reserve and demanded more asset purchases and a nominal GDP target to get GDP level up to the long-term growth trend have essentially got their wish.

This is a radical departure:

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month.  The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities.  These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

The Committee will closely monitor incoming information on economic and financial developments in coming months.  If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.  In determining the size, pace, and composition of its asset purchases, the Committee will, as always, take appropriate account of the likely efficacy and costs of such purchases.

I tweeted this earlier in favour of the idea that the Fed would adopt open-ended asset purchases:

Those who didn’t anticipate the possibility of open-ended asset purchases should have looked much more closely at Bernanke’s words at Jackson Hole:

If we are willing to take as a working assumption that the effects of easier financial conditions on the economy are similar to those observed historically, then econometric models can be used to estimate the effects of LSAPs on the economy. Model simulations conducted at the Federal Reserve generally find that the securities purchase programs have provided significant help for the economy. For example, a study using the Board’s FRB/US model of the economy found that, as of 2012, the first two rounds of large scale asset purchases may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred.

Essentially, this is nominal GDP level targeting. The reason why Bernanke has framed it in terms of lowering unemployment is that his mandate relates to price stability and unemployment, not nominal GDP level. But as Bernanke himself noted in his academic days:

Estimates based on data from more recent years give about a 2% decrease in output for every 1% increase in unemployment.

To those who accept Okun’s Law, raising nominal GDP level and lowering unemployment are effectively the same thing. Bernanke seems to believe unemployment will fall in a (roughly) linear fashion as asset purchases increase. By itself, this is a problematic assumption as the past is not an ideal guide to the future.

Yet more importantly the data shows no real job recovery in the post-2008 quantitatively-eased world. This is the prime-age employment-population ratio:

And even if unemployment falls without triggering large-scale inflation as per the Fed’s design, this is no cure for the significant long-term challenges that America faces.

As I wrote back in November 2011, when nominal GDP targeting was just appearing on the horizon America faces far greater challenges than can be solved with a monetary injection. Financial fragility, moral hazard, energy dependency, resource dependency, deindustrialisation, excessive private debt, crumbling infrastructure, fiscal uncertainty, and a world-policeman complex. The underlying problems are not ones that Bernanke really has power to address.

And how long before rising food prices cause more riots and revolutions? After, all handing over more firepower to speculators tends to result in increased speculation.

Meanwhile, US creditors and dollar-holders (particularly China) would seem from past comments to be deeply unhappy with this decision.

President Hu Jintao:

The monetary policy of the United States has a major impact on global liquidity and capital flows and therefore, the liquidity of the US dollar should be kept at a reasonable and stable level.

The dollars they accrued will lose purchasing power to every new dollar printed and handed over to the American banks in exchange for mortgage backed securities. The Chinese perspective on this will be that Bernanke is essentially engaging in theft. On the other hand, they should have considered this likelihood before they went about accruing a humungous pile of fiat dollars that can be duplicated at a press of a button. No, matter; China won’t get burnt like this again.

As PBOC official Zhang Jianhua noted:

No asset is safe now. The only choice to hedge risks is to hold hard currency — gold.

Chances of future trade and currency wars between the United States and China seem to be rising as fast as Chinese gold accruals.

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America Priced in Gold

Let’s imagine that the gold standard was not abolished in 1971, and was instead maintained — or, alternatively, assume that only gold is money and that other things are merely paper intermediaries. What would be the shape of economic data under that paradigm? Here’s retail gasoline:

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Stagnation Nation?

It has long been my view that most of the seeds of the West’s ills were sown in the 1970s: that was the decade when Western consumerism began to be sated by Chinese imports, and Arab oil, and the decade when America cut the link between the dollar and gold sparked the first flames of the great Keynesian debasement bonfire. Richard Nixon and Henry Kissinger were the chief architects, of all three of these innovations, and the internationalisation of the dollar as the global reserve currency.

In the 80’s, the United States’ trade balance flipped over and the U.S. became a net debtor, sending more and more dollars and debt out to the world as the free lunch got bigger and bigger. But something odd happened from the 70s onwards, as demonstrated by our graphic of the day:

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Keynes, Bernanke, Krugman

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?


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Pentagon Plans for War with China

Has someone at the Pentagon been reading azizonomics.com? While I recognise that all great powers will devise contingency plans, it should come as no surprise that Pentagon resources are being directed toward devising a strategy to fight none other than the single largest Treasury creditor, China. After all, as I have pointed out time and again, they are not happy that so much of their productive output is going to stock Wall Mart, Target and J.C. Penney in exchange for the increasingly devalued dollar. From Salon:

This summer, despite America’s continuing financial crisis, the Pentagon is effectively considering trading two military quagmires for the possibility of a third. Reducing its commitments in Iraq and Afghanistan as it refocuses on Asia, Washington is not so much withdrawing forces from the Persian Gulf as it is redeploying them for a prospective war with its largest creditor, China.

According to the defense trade press, Pentagon officials are seeking ways to adapt a concept known as AirSea Battle specifically for China, debunking rote claims from Washington that it has no plans to thwart its emerging Asian rival. A recent article in Inside the Pentagon reported that a small group of U.S. Navy officers known as the China Integration Team “is hard at work applying the lessons of [AirSea Battle] to a potential conflict with China.” Continue reading →

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How Did We Get Into This Mess?

The chips are down for America; credit rating downgraded, industrial production down, employment lagging. So I suppose that means that political leaders, business leaders, religious leaders and the people of America in general will be simply bursting with ideas to reverse America’s fiscal woes, to boost employment, and to boost productivity? In the Republican corner, 2012 Presidential hopeful Rick Santorum is firing off some big ideas:

I do not have a problem with homosexuals, but a problem with homosexual acts. The right to privacy doesn’t exist in my opinion in the United States Constitution. Anti-Sodomy laws properly exist to prevent acts which “undermine the basic tenets of our society and the family

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