More on Quantitative Easing.....

Several commentators have left some interesting links that are related to the new 'fad' of quantitative easing (printing money), and it seems that this policy is gaining ever greater traction as a policy tool. Perhaps the most interesting example is that of the proposed IMF quantitative easing (QE):

Alistair Darling and senior figures in the US Treasury have been encouraging the Fund to issue hundreds of billions of dollars worth of so-called Special Drawing Rights in the coming months as part of its campaign to prevent the recession from turning into a global depression.

The first thing to note here, is that the calls are coming from the US and UK, which are countries already following the QE policy. That the calls are coming from two of the most troubled economies only serves to illustrate their desperation. This policy proposal is simply a way to try to inflate away the underlying problems, but to do it on an international basis. As for the domestic policies of QE, there is a fundamental belief that economies can be stimulated to act in accordance with government wishes, regardless of underlying economic drivers (for those new to the blog, you may wish to read here for a discussion of the underlying economic reality).

Just to add to the curious situation, both China and Russia are considering / proposing that the IMF could replace the $US as the reserve currency by providing a clearing house, thereby creating a new de facto currency:

China and other emerging nations back Russia's call for a discussion on how to replace the dollar as the world's primary reserve currency, a senior Russian government source said on Thursday. Russia has proposed the creation of a new reserve currency, to be issued by international financial institutions, among other measures in the text of its proposals to the April G20 summit published last Monday.

Calls for a rethink of the dollar's status as world's sole benchmark currency come amid concerns about its long-term value as the U.S. Federal Reserve moved to pump more than a trillion dollars of new cash into the ailing economy late Wednesday.

[And later]

The source said the Chinese paper envisaged the International Monetary Fund's Special Drawing Rights (SDRs) being first assigned a role of a clearing currency on some transactions and then gradually becoming the main global reserve currency. "They said that the role of reserve currency should be given to SDR," the source said.

The idea of the IMF providing a world reserve currency is, to say the least, a very curious one. The IMF has a limited gold reserve, but otherwise is reliant on financing from governments of countries. The following discussion is now out of date, but sets out the status of IMF gold.

The International Monetary Fund currently holds 103m. ounces of gold, valued on its books in August 2003 at $8.1 billion (IMF, 2003a) but probably worth $38.4 bn at market prices. The IMF has no real use for this gold. Admittedly, it provides fundamental strength to the IMF’s balance sheet. However, it is a small amount compared to the IMF’s $350 bn in total resources or its $228 bn in usable currencies (IMF, 2003b). By its Articles of Agreement (IMF, 1945), particularly Articles IV and V, the IMF may receive gold from countries in settlement of obligations, but it cannot lend gold as part of its stabilisation programmes. Nor can it lease, swap or use its gold as collateral. The IMF cannot revalue its gold without selling it, and an 85% vote of the membership is required to authorise such a sale. Were the IMF to sell its stock of gold rapidly in order to generate money to meet an international financial crisis, it would depress the world price for gold and diminish the value of the gold held by countries in their reserves or offered for sale. Various efforts have been made in recent years to use some of the IMF’s gold stockpile to fund debt relief for poor countries. However, none of the efforts or plans proposed to date will generate the needed funds without collateral damage to the IMF or to the gold-producing countries. (1)

As regular readers will be aware, a fiat currency has no real value except the value that is assigned by our collective belief in the value. The question that springs to mind with an IMF reserve currency is to ask what might inspire such a belief. Whilst such belief in an IMF currency is a very curious notion, in some ways it is no more curious than our belief in the value of the $US or £GB. It just serves to highlight the absurdity and fragility of currencies which can be 'printed' without constraints.

The situation in the US is now one where money is being printed without constraint with a significant expansion of QE:

LONDON (SHARECAST) - Bond and gold markets soared but the US dollar tumbled as the US Federal Reserve chief Ben Bernanke unveiled a $300bn treasury bond buy-back plan as part of a new $1.15trn package to rejuvenate the US economy.

In a move mirroring recent actions by the Bank of England, the US central bank said it would move to buy treasury notes with maturity dates of between two to 10 years to “help improve conditions in private credit markets.”

The Fed also moved to prop up the housing market by saying it will buy $750bn of Freddie Mac and Fannie Mae issued mortgage-backed securities, on top of $500bn already pledged to the two agencies. It also doubled the agency debt it plans to buy this year from $100bn to $200bn.

One of the underlying purposes of the policy is to try to prop up the ailing house market. I can think of no better example of the bankruptcy of imagination than this policy, and no better example of a complete misunderstanding of the realities of the current situation. Bernanke is claiming that the QE policy has an end plan, but at the same time offers no actual end to the policy:

WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke on Friday said the Fed's buying of longer-dated U.S. Treasuries would "taper off" when the economy no longer needed help, allowing the Fed to cease its emergency support.

"The time will come when the economy will be growing, the housing market will be recovering, that support will no longer be needed. And we will of course at that point taper off that support," Bernanke told community bankers in Phoenix, Arizona.

Quite simply, I do not 'buy' the idea that there can be any end in sight to such a policy. The US government's borrowing is expanding at such a rate that there is no realistic possibility of raising the finance to cover the exploding costs. In particular China has been funding the US government and the discussion of a move away from the $US as the reserve currency is the final confirmation that the 'game' has come to an end. Once again China has issued warnings to the US:

China hopes the United States will guarantee the security of the Chinese assets and investments in the U.S., China's Foreign Ministry reiterated on Thursday

Foreign Ministry spokesman Qin Gang made the remarks in response to a question on the decision of the U.S. Federal Reserve Wednesday to spend up to 300 billion U.S. dollars to buy long-term government bonds and expand purchases of mortgage-related debt to revive the economy.

The full article is not as dramatic as the quote suggests, with Qin Gang apparently accepting the policy, but the warning still remains. Niall Ferguson in 'The Ascent of Money' called this game 'Chimerica' - the game of China funding US consumption. I made a speculative post recently on how China might finally unwind its funding of US debt, and imagine that it is likely that we will see China moving in a direction approximate to that which I have outlined. The US policy of QE, in particular the move to purchasing treasuries is preempting the end of Chimerica, in the same way the UK preempted a failed bond auction through the introduction of QE.

In the meantime China is now in a position where it is flexing its economic muscles with impunity. Their blocking of the Coca Cola purchase of a Chinese drinks company is an example of their new found power. Quite simply, the US dare not 'take on' China over such a protectionist act.

Whatever the actions of the US government and the central banks, the status of the $US as the world reserve currency was always going to be challenged, but the moves of the Fed will now simply accelerate the decline. I have continually predicted the collapse of the $US, and have been endlessly surprised at the resilience of the currency. Up to now, there has been a delusional belief that the reserve status of the $US would somehow 'save' it, regardless of the actions of the US government. A while ago I wrote a post specifically to point out the many reasons why the reserve status would not save the $US, and the policy of expanding QE to purchases of treasuries simply adds to the many reasons for why it cannot resist collapse.

As I am writing this post, I can not help but find the situation in the world economy to be ever more surreal. When I first started writing this blog, whilst being able to see the oncoming crisis, I could never have imagined that the policy makers would take actions that could take a major crisis and turn it into catastrophe. I am genuinely baffled that so many otherwise intelligent people, are undertaking the policies that they are. Several months ago, when QE policy was first being proposed for the UK, I commented on the strange way in which the Economist magazine was reporting the policy. I will quote from my post (I will not put it in block quotes as it is fairly long):

[quote starts]

This from the Economist magazine (a magazine I once had great respect for and for which I am a print subscriber):

'This is where the Fed has already been inventive: printing money to buy all manner of assets. In October it said it would buy short-term commercial paper. This week it unveiled two new schemes: a $600 billion plan to reduce mortgage rates by buying government-backed mortgage securities and the debt of America’s state-sponsored mortgage giants; and a $200 billion scheme to buy the debt backed by credit-card, car, small-business and student loans (see article). This approach could be broadened to other markets that have shut down. For instance, there is little fresh (senior) credit for firms in bankruptcy. If the government can provide that cash, it could stop the coming wave of bankruptcies from becoming one of corporate liquidations'

Apparently, printing money is now 'inventive'. Here is the same magazine discussing Zimbabwe:

'WITH prices doubling every few days, Zimbabweans now spend huge amounts of time and energy preventing their meagre cash resources from completely evaporating. Trying to catch up with galloping hyperinflation, now officially running at 2.2m per cent a year and at least four times faster in reality, the central bank has been printing ever bigger denominations. But it is outrun by galloping prices:'

And:

It may seem odd that the local currency is still used at all. From Z$25 billion to the American dollar at the beginning of this month, the cash exchange rate had jumped threefold within a fortnight. In restaurants or shops, prices are still quoted in local currency but revised several times a day. Salaries are paid in Zimbabwean dollars, still the only legal tender. A minibus driver taking commuters into Harare every day still charges his clients in Zimbabwe dollars—but at a higher price on the evening trip home—and changes his local notes into hard currency three times a day. The local money is losing its relevance.

So apparently the printing of money is a disaster in Zimbabwe, but if Western countries do it, it is 'inventive' and to be commended.

[Quote ends]

The reason for quoting at such length is that the Economist's thinking illustrates the central delusion that Western economies are 'well managed', and that problems such as hyper-inflation are only applicable to non-Western countries. It appears to be a quite astonishing form of arrogance built upon a self-satisfied sense of superiority. The belief is that 'it can not happen here', but there really is no justification for such a belief. I can not see any difference between the policies in the UK and US and those in Zimbabwe.

However it is spun, both governments are now funding large part of their operations through printed money. Whilst the mechanisms and methods may not be so direct as those being used in Zimbabwe, there really is no fundamental difference, except that lots of people are now saying that when the UK and US print money, it is a 'good thing'. Both the UK and US also claim that the policy is temporary, but both governments had structural deficits before the crisis, both are taking no action to restrain the deficits, and both are in fact expanding the size of the deficits. Under such circumstances, it is difficult to see any point at which the policies might be reversed.

The article that I quoted regarding the Economist was titled 'Money Printing Economics - The UK and US as the New Zimbabwe?' I think that the time has arrived where the question mark in that title can now be removed.



(1) Jonathan, ES 2004, 'IMF Gold and the World Bank's Unfunded HIPC Deficit', Development Policy Review, vol. 22, no. 1, pp. 31-40


Note 1: Sorry for the lack of posts recently, but I have been distracted again by other commitments. Many thanks for the many useful links and the interesting discussions in the comments sections. I am endlessly encouraged by the intelligence of the comments, and some of the insights that are presented.

Note 2: I hope that you do not mind yet another article on QE. I am focusing on the subject as I can think of nothing else as important in the current crisis as these policies. I will move off the subject for my next article, in which I am planning to discuss some broader indicators of the state of the UK economy, and possibly also the US economy.

Note 3: I have had confirmation that I will have an article published in the Trade and Forfaiting Review, and will link to the article once it is published. The magazine specialises in trade finance, and also has some very interesting articles that are likely to be of broader interest.