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Stocks Blast Higher After Japan’s Quantitative Easing Surprise

The Japanese economy has been locked in a deflationary malaise for nearly two decades now, and while that has many causes, some indigenous and unique to their economy (e.g., aging population), Japan is also caught up in the global economic malaise for the obvious reason they depend on exports and can’t sell their products when foreign consumers don’t spend.

Just two days ago, the U.S. Federal Reserve ended its third round of quantitative easing (QE). Financial markets love QE; it’s the rocket fuel that has dramatically boosted U.S. stocks, and probably also U.S. home prices, since our financial markets bottomed in March 2009, a few months after the depths of the financial crisis, which began in the U.S. with the collapse of housing and quickly spread to the entire world.

Markets don’t much care where QE comes from; investors are tickled to get free money, regardless of which government gives it to them. After three rounds of QE from the Fed, a very clear pattern emerged in which stocks shot up every time the Fed started a new QE, and went into a funk every time a round of QE ended. U.S. stocks began selling off sharply last month as the end of QE3 approached. Now, we have a brand new QE from Japan, and stocks are bouncing right back up. This morning, the Dow Industrial average is up nearly 200 points; the effect in Japan was even more dramatic, as last night their stock market jumped the equivalent of 800 Dow points. Using a broker like XM can help you make sense of all this complex theory behind the stock market, if you’re thinking of getting involved yourself. Trading can be fun as well as very profitable, but it is also risky business which is another way in which brokers can help; by giving you guidance. It’s an interesting hobby as the stock market has an impact on everything.

Working stiffs — whether unemployed, or employed but without pay raises in years — complain that little or no free money trickled down to them. (That’s not quite true; they got extended unemployment benefits and food stamps.*) It’s true the labor that creates all wealth, without which capital is unproductive and worthless, didn’t get much, if any, personal benefit from QE. But to hell with them; we’re a capitalist country, and sucking up to capitalists is what we do. If you don’t like it, move to North Korea, where the Workers Party runs everything (including the forced labor camps that house many of their workers).

(* Meanwhile, bankers got to keep their bonuses earned for crashing the economy, and not go to prison; millionaires became billionaires; and damned little of the largesse used to engineer the complicated rescue of the U.S. economy reached their victims.)

QE is complicated to explain, and even I don’t understand all its tentacles. I’m not sure anyone does. But I’ll do my best.

Capitalist economies are cyclical. Everyone’s heard of the business cycle, right? Beyond that, such economies also are vulnerable to financial panics and banking crises. Because of that, we’re had repeated experiences with the things that can wrong with a capitalist economy, and people with any brains have learned from those experiences.

History amply demonstrates that when the economy enters a contractionary cycle, the worst and stupidest and most dangerous thing you can do is adopt conservative economic policies, which are guaranteed to make the situation worse. Now, granted, people still debate what caused the Great Depression of the 1930s. Just like they debate the non-existence of climate change and the non-health threat of cigarette smoking. Some of the rational minds out there plausibly argue that the main cause of the Depression was the effing gold standard.

The same gold standard that today’s libertarians and Paulistas want to restore. The gold standard that doesn’t allow money supply to expand in tandem with a growing economy, which means that if you’re locked into a fixed money supply, your economy can’t produce more except by depressing the prices of everything, which sets off what economists call a “deflationary death spiral.” The colorful descriptive gives you an idea of where it leads.

Of course, there were other causes too, not least the Republican policies of the late 1920s and early 1930s that turned an ordinary recession into a gargantuan depression by, among other things, cutting government spending at a time when private spending was collapsing. Keynesians plausibly argue that’s the worst thing to do, and when an economy is collapsing, you should increase government borrowing and spending to put money in circulation and stimulate consumer spending. History has repeatedly proven the Keynesians to be right, but that doesn’t stop today’s Republicans from hating Keynesian policies and using “Keynesian” as an epithet much like they use “liberal” and “socialist” as epithets. Perhaps the cutest personal trait of America’s contemporary conservatives is they not only insist on being wrong, but also demonize those who are right.

In the fall of 2008, when the credit system seized up like an engine without oil, it looked like the world was ending. Conveniently, this occurred right before the presidential election, instead of right after, which helped the black Kenyan commie get elected and assured that U.S. economic policy for the next four years would not be based on disastrous Hooverite thinking. It was a close call and we dodged a bullet that time, but it’s an aside, and I need to keep this discussion on track, so we’ll leave that subject now.

People were scared shitless and stopped spending. Especially when banks began collapsing and a public that had been taught by Republicans to fear, hate, and distrust all forms of government didn’t feel confident they would get their bank deposits back (because, you know, we can’t trust the FDIC). What happened next was a giant sucking sound of money being pulled out of circulation and going into mattresses. That’s when the Fed stepped in with QE1, which flooded the economy with something like $1 trillion of new money created out of thin air.

Conservatives threw up their hands in horror and predicted America would be ravaged by Weimar-type hyperinflation. Some of them were in the business of selling gold, guns, and survival rations, so they had a pecuniary interest in the public falling for this bombast. Of course, it didn’t pan out, there was no inflation. How can this be, when you’re printing money? Everyone knows money supply expansion is what caused inflation. Simple. QE1 didn’t expand the money supply, it merely kept it from shrinking, by replacing the money that had been withdrawn from circulation by all the scared rabbits stuffing cash into mattresses.

Also, inflation isn’t caused so much by more money supply as by inflationary expectations; according to reputable economists, inflation is mainly caused by workers demanding higher wages because they expect prices to go up. In other words, inflation seems to be very much a psychological phenomenon. Conversely, needless to say, there’s also a large psychological component in deflationary behavior, such as hoarding cash or deferring spending in expectation of lower prices later on.

I know your head is probably spinning by now, but bear with me. There’s more, and it’ll benefit you to understand what’s going on, so you know how to manage (and how not to manage) your own situation.

I think QE1 was absolutely necessary and is one of the key reasons why the Great Recession didn’t turn into a Great Depression 2.0. In fact, nearly all of the economic policy decisions made from 2008 onwards were the right ones. So you should thank God that Republicans lost the 2008 election, because our asses would be up the creek if they had won.

Which brings me to this: There are two kinds of economic stimulus you can use in a bind, i.e., monetary stimulus and fiscal stimulus. Monetary stimulus is when a central bank prints money and floods the economy with cash. (This is where Bernanke’s famous and apocryphal “helicopter drop” comes in, wherein the government drops cash into streets from helicopters, the idea being that whoever picks it up will spend it, thereby stimulating the economy and restoring it to health.) Fiscal stimulus is when Congress borrows money and spends it on things like unemployment benefits, food stamps, employing people to repair infrastructure, cash grants to states and cities to keep teachers and cops on their payrolls, and so on.

Like printing money, this puts cash in circulation, which enables ordinary people to spend, which is the obvious and logical cure for a sick economy whose problem is that people aren’t spending. Note this works only if government borrows money for the extra government spending; it doesn’t work if you pay for this spending by raising taxes, because then you’re taking as much money out of circulation as you’re putting into circulation, which neutralizes the whole thing. But that’s exactly what conservatives want to do, because they think deficit spending is evil, which is why Republicans will always turn a recession into a depression if you allow them to.

Between the two, fiscal stimulus is far more effective than monetary stimulus. I’m not sure why; it just is. Probably because it more directly puts new money into circulation, and does it faster; I’ll explain this further below. Just bear with me for now.

This created a problem. A president can appoint a Federal Reserve chair and board that will get things done, but the Fed’s authority and power extends only to effectuating monetary stimulus (which also can be accomplished by cutting interest rates, see below). Fiscal stimulus must be shoveled through Congress. This is very dicey, because borrowing huge amounts of money when the economy is collapsing is counterintuitive, and congressman are nervous about voting for it, because it doesn’t look good to the constituents back home who are being told by Republican propagandists that deficit spending is morally evil, will burden their children and grandchildren, bankrupt the country, and saddle the economy with slow growth for decades to come. This is complete nonsense, but it sounds plausible, so a lot of people believe it.

Consequently, even when Democrats held the White House, the House of Representatives, and a filibuster-proof Senate majority after the 2008 election, they were only able to pass $930 billion of fiscal stimulus (in addition to $750 billion of financial bailouts, most of which went to banks and AIG, the giant insurance company). This sounds like a lot, but it was much less than Keynesian theory and many reputable economists said was necessary, with predictable results: The slide from recession into depression was arrested; layoffs slowed, stopped, and by 2010 employment began growing again; and GDP stopped sinking and began growing, albeit slowly. The “slowly” resulted from the fiscal stimulus not being large enough. In other words, the results of such fiscal stimulus as our country’s dysfunctional politics allowed to occur were all positive, but thanks to Republicans screaming these policies would lead to ruin, there weren’t enough of them so we got stuck with a sluggish recovery and persistent high unemployment. And, after voters handed the House and the power of filibuster in the Senate back to Republicans in 2010, any further fiscal stimulus was off the table, other than a hard-fought modest extension of unemployment benefits.

This left the Federal Reserve’s monetary stimulus as the only recession-fighting tool available from 2010 onwards. QE2 and QE3 worked the same as QE1, but had fundamentally different purposes and effects. The Fed policymakers knew perfectly well that QE inflates asset values. Adopting a policy that would do this was intentional. The idea was that if people felt richer because their houses and stock portfolios were worth more, they’d loosen up and start spending again. This is called (derisively in Bernanke’s case) the “wealth effect.” Unfortunately, this didn’t work very well. Americans still love to spend, but there were a couple of major impediments: One, you can’t spend your increased home equity if banks won’t lend against it; and two, most ordinary American household comprising the core of the consumer spending corps don’t own stocks, so higher stock prices don’t make them richer or give them spendable cash. The Fed types probably knew this, too, but QE and ZIRP (zero interest rates, to make borrowing cheap) was all they had. With Congress doing nothing on the fiscal front, they figured it was better than nothing.

ZIRP is designed to encourage private deficit spending. Ironically, Republicans think deficit spending is great when individuals and companies do it, perhaps because they make money from that, and consider deficit spending evil only when government does it to provide public services and life support to beleaguered laid-off workers. And it certainly did, but not in a way that helped the economy very much. Households didn’t borrow much interest-free money, because banks wouldn’t lend to them, but big corporations borrowed trillions of dollars. Because nobody was spending, so they couldn’t sell stuff, they didn’t use it to hire workers to make stuff; instead, they used it to buy back their own stock and give their shareholders dividend raises. The last five years were a golden age for shareholders. Because the rich own most of the stock, they got fabulously richer. Little of this trickled down to the working class, or the unemployed; but to hell with them, this is a capitalist society, which quite naturally sucks up to the capitalists.

Now let’s go back to what QE is, how it works, and why it doesn’t cause inflation as Republicans claim or create jobs as Democrats vainly hoped it would. QE consists of the Federal Reserve creating new money out of thin air and using it to buy bonds from banks. Throughout all three QEs operations, the Fed bought two types of bonds, U.S. Treasuries and MBS (mortgage-backed securities), which in effect are bundles of mortgage loans. All of these MBS came from Fannie and Freddie (or, at least, that’s my understanding), so in effect these MBS purchases took mortgages off banks’ hands in exchange for liquidity (also known as cash). (Cash is liquid, i.e. instantly spendable, whereas mortgage bundles are illiquid, i.e. you can’t use them to buy stuff until you convert them to cash by selling them, that is if you can find a buyer, which is where the Fed comes in.)

The three QEs were massive. They created over $3 trillion of new money, about the amount of all the money previously in circulation. The reason QE didn’t cause inflation is because this new money never went into circulation. When the Fed paid it to banks in exchange for Treasuries and MBS, it landed in bank reserve accounts on deposit at the Fed and stayed there. This increased the banks’ reserves and made them solvent, which was very useful, and also took essentially all of the new Treasuries being printed to finance the government’s deficit spending off the market, which also was very useful. In other words, when the fiscal side of the government — the side that spends — needed to borrow money, the Fed created money out of thin air and lent it to Uncle Sam. Printing money and then lending it to yourself can come in damned handy when an economy needs Keynesian stimulus to survive.

How QE shoves asset prices higher is a bit murky. This is best thought of in terms of QE and ZIRP working together to push down interest rates. Lower interest rates raise bond and stock prices as follows. Let’s say the market pays 5% for money. A bond of $100 nominal value then pays $5.00 interest. Then policy forces interest down to 2 1/2%. Now, to get $5.0o of interest, you have to buy $200 of bonds. Which means you can sell that $100 bond for $200. Stock yields work the same way; when interest rates fall, a given amount of dividend income costs more to buy. In the housing market, lower borrowing costs enable buyers to pay more for a house with a given monthly payment, and market competition then pushes up house prices. This is exactly what the Fed’s attack on interest rates with its twin policies of QE and ZIRP wrought.

As previously mentioned, the primary purpose of QE1 was to prevent a collapse of money supply caused by cash hoarding. QE2 and QE3, although they were carried out the same, had the very different goal of stimulating consumer spending by creating a wealth effect by reinflating asset values. The reinflation worked, but consumer spending stayed in a funk, for several reasons: Debt, unwillingness of banks to lend, unemployment, lack of wage increases, etc.

Nowadays, money easily jumps over borders, and circulates globally. So, when one country’s central bank tries to stimulate its economy by doing a QE, the QE effects spill over into all the economies. For financial markets, it makes no difference whether the QE comes from the U.S. Federal Reserve or the Bank of Japan. By replacing the Fed’s QE with its own QE, the Bank of Japan has given stocks all over the world another adrenaline shot. Wall Street expects the European Central Bank (ECB) to be the next central bank to resort to QE, because Europe is sliding back into recession. There are some political impediments to QE there, particularly in Germany, where people believe the Weimar Republic’s hyperinflation led to the Nazi nightmare, and like Americans they buy the conservative-peddled nonsense that QE will cause hyperinflation. So the ECB hasn’t done QE yet, but Mario Draghi, who runs the ECB, is making QE noises, so the financial markets think he will sooner or later.

All of this is great for people who own stocks and expensive houses. The Dow is up almost 200 points this morning. The rich are getting even richer; their prospects seem almost infinite. Japan’s QE, like the Fed’s QE, probably isn’t hurt the non-stock-or-mansion-owning masses very much, if at all, but it probably isn’t doing them much, if any, good either.

Obviously the thing to do in this environment is be a capitalist instead of a worker. If you’re working for wages, the worst way of getting money there is under our system, you’re just cannon fodder. A useful tool for the capitalist class — as long as you keep giving them your labor cheap or free. The thing to do is pay off your debts, then use your income to buy assets (I prefer stocks). Of course, this means ratcheting down your lifestyle and spending a lot less. If everyone does that, we’ll have one whale of a depression. Maybe one that will make the 1930’s look like child’s play. But I think that’s unlikely. Only a few of us have the self-discipline to live on next to nothing in order to rise from the working class to the capitalist class.

Being a capitalist isn’t for the masses. Only some of us can be capitalists. If everyone becomes a capitalist, policymakers will have to suck up to all of us, and if that happens we may begin to resemble an actual egalitarian democracy.Roger Rabbit icon

 

 

 

 

 

 

 


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