The Best of Economic Times, and the Worst
12:00 AM, Nov 13, 2010 • By IRWIN M. STELZER
This is a tale of two printing presses.
It is the best of times, the worst of times. The U.S. government will continue spending more money than it is taking in from taxes, despite a warning from the president’s budget commission that the situation is unsustainable and risks a blow-out in the market for U.S. IOUs. The worst of times. So the first printing press well be put to work printing Treasury bonds, or IOUs, promises to repay the loans at some future date, and interest until then.
Meanwhile, the Federal Reserve Board’s monetary policy committee will activate the second press, and not for the first time. It will print $600 billion with which to buy the next eight-months’ output of the Treasury’s presses, and that doesn’t count the $300 billion from expiring mortgages that it will reinvest in additional Treasury securities. That will keep the price the Treasury has to pay investors -- the interest rate -- low, and drag down other interest rates as well.
Which makes investors look for a better return on their money. Buy shares. Not much of a risk since the chairman of the Fed, Ben Bernanke, has announced that since share prices add to wealth, added wealth results in added spending, and added spending creates jobs, he will support share prices -- the so-called Bernanke “put.” The best of times.
Voila! Investors bid up share prices and, according to an estimate by the Lindsey Group, Americans were instantly $2 trillion richer than a few months ago, making it likely that the GDP will increase by a non-trivial 0.4 percent more than it otherwise would. Surely, the best of times, the age of wisdom rather than of foolishness.
With all those dollars sloshing around, the value of the dollar falls, making it the best of times for U.S. exporters, whose goods are now cheaper in terms of euros, sterling, Brazilian reals, and other currencies. Of course, the flip side of that coin is that foreign goods are more expensive in America, making it the worst of times for Wal-Mart shoppers and other consumers. Still, imports are down, exports are up, and the trade deficit is falling. The best of times.
President Barack Obama, of course, could not directly influence the independent Fed, a point not easy to explain to the Chinese at the G20 meeting: The leaders of China’s regime are unfamiliar with institutions independent of central control. Besides, when Obama chose to break with tradition and comment on Fed policy to defend Bernanke’s decision to launch QE2, he created the impression that he had been complicit in the Fed decision that drove down the dollar, which reduced any support he might have had from other leaders of the G20 for his call to end currency manipulation by some dozen countries in addition to China. Instead, charges of hypocrisy, beggar-thy-neighbor protectionism, and cluelessness, to mention only a few, emanated from Germany, Japan, Brazil, and developing nations that fear an influx of hot money -- cash in search of higher returns than are available in U.S. Treasuries, but subject to rapid withdrawal at the first whiff of trouble. From Obama’s point of view, such opprobrium makes this the worst of times, if you don’t count the recent congressional elections.
With Republicans soon to be in control of the House -- the old gang sits until the end of the year -- and having a blocking minority in the Senate, Obama has little chance of pushing through Stimulus 2. The only way the 9.6 percent unemployment rate can be substantially lowered by the time the 2012 elections roll around is if Bernanke is right and QE2 gives the economy a shot in the arm. Or so Obama, no believer in lower taxes or the other growth enhancers favored by conservatives, believes. So for him, although the very best of times would have been a smashing win at the polls earlier this month and a Congress willing to approve Stimulus 2, the second-best of times was when Bernanke matched the activity of the bond presses with reactivation of the cash presses.
Of course, if increasing national wealth by trillions of dollars, and creating million of jobs, merely required punching the “start” button on a pair of presses, America could speed up its sluggish recovery by doing it again. And again. Alas, permanent wealth cannot be so easily created. At best, increasing the money supply can provide a temporary boost to growth, not a bad thing just now, if two conditions prevail. The first is a shortage of credit, the second is a workable exit strategy -- knowing when to stop the presses, and how to call in or offset the cash that was created, before inflation takes off.
The first condition does not seem to be present. U.S. corporations are sitting on $2 trillion of excess cash, and the banks have ample lending capacity. QE2 is not likely to persuade the large banks to ease the tight credit standards now facing homebuyers and small businesses. Or induce businessmen to invest until they see some recovery in demand for their products. In Keynesian terms, Bernanke is pushing on a string.
The second condition required for QE2 to work without creating long-term damage is that the Fed know when to exit, and how. Bernanke says it does. But the Fed now has $3 trillion in assets on its balance sheet, and if it begins any substantial sales, it might cause a sharp downturn in the prices of shares and other assets. Especially, as is likely, if it decides to do so just when other market players reach the same conclusion and head for the exit. To whom, then, could the Fed sell trillions in assets, which is what exit means?
A whiff of inflation is one thing, the best of times if kept in the 2 percent range; let it hit double digits and we feel as if we are living in the worst of times. Doubt that, and recall the malaise created by Jimmy Carter’s double-digit inflation until the combination of Ronald Reagan and Paul Volcker sweated it out of the system. That sort of inflation will be avoided if Bernanke indeed knows when to exit that policy, and also knows how to exit it. Get that right, and -- with further apologies to Dickens -- he will have a good claim to have ushered in the age of wisdom, and ended the age of foolishness, in this context one in which monetary policy is unnecessarily hampered by the fear of runaway inflation. Many people think such knowledge is denied ordinary mortals, even central bankers, which explains the scramble for $1,400-per-ounce gold.
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