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Dallas Fed President on Why He Opposed QE3

Richard Fisher says we don’t know much about why the economy is stalling [1], but we do know one thing: liquidity is not the problem.

Our engine room is already flush with $1.6 trillion in excess private bank reserves owned by the banking sector and held by the 12 Federal Reserve Banks. Trillions more are sitting on the sidelines in corporate coffers. On top of all that, a significant amount of underemployed cash—or fuel for investment—is burning a hole in the pockets of money market funds and other nondepository financial operators. This begs the question: Why would the Fed provision to shovel billions in additional liquidity into the economy’s boiler when so much is presently lying fallow?

Despite his opposition, he gives generally high marks to how the Fed has handled the crisis. If you’re looking for the source of the present economic stall, he says, look at your local member of Congress:

[T]hey fight, bicker and do nothing but sail about aimlessly, debauching the nation’s income statement and balance sheet with spending programs they never figure out how to finance.

I am tempted to draw upon the hackneyed comparison that likens our dissolute Congress to drunken sailors. But patriots among you might take umbrage, noting that a comparison with Congress in this case might be deemed an insult to drunken sailors.

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#1 Comment By Geoff Guth On September 22, 2012 @ 10:21 pm

The problem is that the Fed needs a way of getting all this money it’s creating into the hands of people rather then banks or financial institutions. People would actually spend it.

Unfortunately, the Fed has no way of doing that. Congress could, but is incapable of acting (or chooses not to as an election ploy). Hence our predicament.

#2 Comment By Cascade Joe On September 22, 2012 @ 11:37 pm

Maybe QE3 is about WE HAVE TO DO SOMETHING !!

No, not necessarily. In watching large companies buy automation equipment, I noted that every 4 years things sort of stopped around July. Then came November, somebody won the presidency (it didn’t seem to matter who), and things picked back up.

Never could figure that out.

#3 Comment By Georgina Davenport On September 23, 2012 @ 1:05 am

I have read a few blogs by Paul Krugman on this, he of course is in favour of QE. But I still do not understand it. What is the thinking behind the supporters of QE and why in your opinion are they wrong?

#4 Comment By TomB On September 23, 2012 @ 12:24 pm

Hi Georgina, I sympathize with your position because so much of this economic talk just assumes lots that people without some economic background don’t know about.

(Not to mention that lots of the economic talk is by people who *themselves* don’t know the basic economic background, but just think they do and are partisans of things they don’t even understand.)

So anyway here’s the idea:

The country is in a slump. A slump of economic activity. People aren’t buying, and thus people aren’t producing. Simple enough there, right? You aren’t going to find many people disputing that when people are buying like mad, and producing like mad, and there are jobs enough to pay for the buying, that that is a good economy. Indeed, it’s the Holy Grail of such things. Full employment, lots of spending, not too much debt accumulation … Happy Times.

Okay, so we are in this slump. One school of how to handle such slumps is for the government, by various means, to simply pump money into the system to get out of it. And one of those ways is for the Federal Reserve to buy commercial assets from private banks. (Usually “commercial paper” which are just loan documents issued by huge companies.) This is Quantitative Easting and obviously pumps money into the banks in the hope that the banks then lend at least some of that money out, and people start buying and investing with it, and wallah, we climb out of the slump.

Then, later on when things are humming and flush again, the idea is that the banks buy back those assets from the Fed., or the Fed sells them itself and hopefully things get back to square for the Fed’s books, right? No more being the owner of commercial assets.

Okay, so all this is sort of in the school of “Keynesianism”: The economic school of thought that says that yes, when in a slump the gov’t *should* pump money into the system to get it out of same. And this idea has indeed seemed to work a good number of times in the past, and has some considerable logic to it, and then there’s the Big Kahuna of fear that what the government did wrong at least at first to establish the Great Depression was doing the *opposite* and tightening *its* belt too, which, many think—like Ben Bernanke—is what made the Great Depression so bad.

Now of course there is a major school of people who think that all this is bunk, although I think it’s fair to say that they would admit that *sometimes* Keynesian pumping has worked, and *sometimes* okay. After all, even Milton Friedman is credited with giving Nixon the saying “We are all Keynesians now.”

And I think they would admit that *their* prescription for what do to in most slumps is a little more difficult to explain than Keynesianism, and that there’s a bit of counter-intuitive logic to it that’s not as easily acceptable.

So, here’s the situation: The staunch Keynesians like Krugman say “We’re in big slump, we need big pumping, pump it up.” And Keynesianism is still the reigning school, I think, and regardless it has Ben Bernanke in it.

The staunch non/anti-Keynesians say “baloney.”

And the middle of road people, which I think most economists are, if still Keynesians mostly, are what might be called “point” people.

That is, they agree that most times or at least some times in slumps some pumping is smart.

But, I think more and more people are worrying, there’s a point at which more pumping not only isn’t working, but at which it becomes dangerous if not terrifying.

What, after all, is the Federal Reserve doing when it buys these assets? Or indeed even when it does its more usual job of buying Treasury Bonds?

Well, it’s essentially *lending* the full, mighty weight of the word of the U.S. government behind the debt it incurs. No one else in the world, no other country in the world carries such awe. The Fed is essentially saying “We the United States will make good this debt,” so that it is effectively *lending* its credibility to the private market.

Okay, I think most people think: In most instances that’s okay to get the private market out of a slump. The U.S. is going to be around for a long time, the slump will ease, the U.S. will pay that debt back, no problemo. If you can’t trust the U.S., well my God who *can* you trust?

But now what you are seeing more and more is people saying A) it’s not working, and B) you are even getting to the point where nobody is *accepting* the U.S.’s word anymore The figures are such that there’s less and less chance that the U.S. will *ever* be able to pay all that debt back.

In short, that we are heading for Third-Worldom where you *aren’t* going to trust the word of a government that looks like Bolivia or etc. Whose books are such a mess that it could default on its debts any day, or allow hyper-inflation to just totally wreck its people.

So, there’s some against QE because they are against all Keynesian efforts, but ever more, I believe (although I’ll admit my similar thoughts and such bias here) you see more and more people saying we are getting into crazy times here. Bernanke has put us on the hook for *trillions,* and even with wild inflation there’s just no way we are going to be able to pay all that back.

In essence that we’ve well reached the point where the QE isn’t working because people are no longer believing the the U.S. *can* keep all the promises it’s made.

It’s a judgment call, and not an easy one to be fair I think: To be as fair as possible to the Krugmanites, they say there’s no option: Even if it means the U.S. takes a century to pay off all the debt it incurs now it’s worth it because we are staring into the absolute economic abyss. Another Great Depression if not worse. And that’s scary and I think there is at least some logic there.

Others however say that we’ve reached the point where all this is doing is making things *worse* down the line. Essentially trashing The Greatest Asset the U.S. has which is its full faith and credit.

Ergo … you judge. What I think most reasonable people *would* agree on is that we are in uncharted economic territory here given the size of the debt we have and what our future outlays look like.

As an example when I was in University (the ’70’s) I don’t think you could find one single professor in my economics department that would agree that another Great Depression was possible. Not one. And I doubt you could find many in the whole country who thought that was reasonably possible. “We had just gotten too good and understood things too well” was the idea. Keynesianism especially, it was thought, had proven itself fantastically in the ’60’s, so what was the problem? A slump? Just … gin up the government spending.

But now I suspect you’d be hard pressed to find any economist who said another Great Depression was *im*possible. What happened in 2008 scared the hell out everyone, with good reason.

In the end, Georgina, the best (if not only) economic idea I learned in University is that economics is really just a branch of human psychology. With a major part of it being the psychology that goes into adjudging trust, value, worth.

You sell a table and accept a dollar bill trusting that tomorrow that dollar bill will be accepted as worth the same. But what happens when you no longer believe that? Big time?

And, I would say, lots and lots of people today, including the most sophisticated at big banks and etc. are saying … nope, our trust is fading, baby, big time. I ain’t gonna be buying, and I ain’t gonna be investing, and I ain’t gonna be lending and I ain’t gonna be spending. Because all they see is the criminals in Congress behaving—as they have now for way too long— like drunken if not traitorous sailors.

And who the hell can fault them that perception?


#5 Comment By Gilbert Berdine On September 23, 2012 @ 3:08 pm

Geoff Guth,

“The problem is that the Fed needs a way of getting all this money it’s creating into the hands of people rather then banks or financial institutions. People would actually spend it.”

This is intentional. If the money gets into the hands of people and they spend it, then prices go up. All of the newly created money is sitting idly on deposit with the Fed by design. That is why early into the crisis the Fed chose to pay interest on these deposits. The money improves the balance sheets of banks so they can appear to be solvent.

#6 Comment By Gilbert Berdine On September 23, 2012 @ 6:45 pm

Georgina Davenport,

“I have read a few blogs by Paul Krugman on this, he of course is in favour of QE. But I still do not understand it. What is the thinking behind the supporters of QE and why in your opinion are they wrong?”

QE was never about stimulating the economy. It was about helping out the big banks.

If the Fed wanted to get money into the hands of people so they could spend it, thereby “stimulating” the economy, then Helicopter Ben would just drop money from helicopters like he said he would. The people of the Fed know this would cause prices to rise and they do not want prices of ordinary things to rise. They only want stock and home prices to rise. The Austrian theory of the business cycle explains why printing money does not work, but it is complicated and would require a long discussion to explain it. It has to do with the capital structure of a producing economy and interest rates as the expression of the time preferences of consumers.

But even if dropping money from helicopters would work, that is not what the Fed did with QE. The Fed creates money from thin air, then trades it to special banks for either Treasury Bonds (QE1 and QE2) or Mortgage Backed Securities (all the QEs). The banks do not lend the money out. The banks park the money with the Fed. The Fed pays the bank interest on the money. In the case of MBS, the bank gets money in exchange for a security that was heavily discounted due to non performing loans. In the case of Treasuries, the bank is a primary dealer for the Fed and gets to Front Run the trade. There are large sums involved, so even 0.25% leads to nice bonuses for bank executives with zero risk involved.

QE was never about stimulating the economy. QE was always about improving the balance sheets of large banks so they would appear solvent. This is all about the Emperor’s New Clothes. The US dollar is backed by the full faith and credit of the US. Appearances are everything for fiat money.

#7 Comment By Charlieford On September 23, 2012 @ 8:54 pm

If you’re looking for the source of the present economic stall, he says, look at inequality and the stagnant middle class (as Geoff points to, also).

Since the 70s, we’ve moved from an economy that focused on the middle class–skilled workers, professionals–to one that diverts more and more revenue to compensating executives.

The middle class is what buoyed the economy with purchasing, but that was sustained largely by borrowing. The great borrowing binge is over, of course. But so is the purchasing required to support the economy. Hence manufacturing is getting hammered again.

QE3 is being done basically because it’s all the feds can do at this point. The president’s jobs plan is dead in the water. We’ve already tried tax cuts. We could start slashing at regulations, but it’s not as if a sudden burst of regulatory enthusiasm during the Bush years was responsible for the collapse–so all we’d get is more depradation of the envireonment and less safe working conditions and more risk putting us in jeopardy–but no recovery.

OWS had the right basic idea–but it was composed by a bunch of goofballs. So . . . what we need, it would appear, is World War II.

Can someone call Japan and tell them we need a favor?

#8 Comment By S Peter Cordner On September 23, 2012 @ 10:54 pm

It goes a little deeper than that. By creating the EXPECTATION of inflation, then you can get a lot of inflation-driven effects that are otherwise impossible while jammed up against the inflation floor. Expectations of inflation (hopefully) then spark investing and getting liquidity to actually move, since you want to chase investments in the face of inflation rather than watch yourself lose money.

QE3, specifically targeting mortgage securities and operating apparently unendingly, is intended to try to get cash slowly into the housing market as well as create expectations of future inflation.

God help us all. 😛