EPTOn October 26 2012 15:32 lOvOlUNiMEDiA wrote:
In the course of a conversation with a friend, I did my best to understand Quantitative Easing through an Austrian perspective. This was the fruit of that labor and I did my best to convey what I learned using a simple vocabulary. So for whatever it's worth, here you go:
(1)It's true that without "money" the economy would stagnate (bartering is relatively inefficient). But just what" money" is and how it's "value" is determined is, in essence, the entire point at stake because in the case of QE, you have an institution creating, out of thin air, something that is supposed to have value. Unfortunately it can't do this. Yes, it can create the money. But no, it can't create actual values. To understand why it can't do this, you've got to recognize that the only reason markets exist is because things that have value are not free. Anything that's free is not on the market (who would buy something that's free?) Anything that's not free cannot be be magically created, for example, by punching numbers into a computer at the fed. Elaborating on this fact is the bulk or my reply below.
I'm going to start the bulk of my reply by focusing on your conclusion proper. First, if you want me to accept as true your claim that growth in the money supply is necessary for economic growth then you need to explain why that's true (You don't provide an argument, you just state your conclusion). (2) You'll also need to explain why the fed doesn't "print" a trillion-trillion dollars right now to "grow" the economy at a great rate. Finally, (3) in order to differentiate a policy difference between printing 600 billion and a trillion-trillion dollars, you'll need to at least lay out the justification behind the basic methodology used to formulate the "correct" amount of dollars to fabricate.
It seems to me that my task is much easier because my view of what causes growth in an economy is simpler: economic growth is nothing but the result of more profit for the same or less effort. Period (e.g., a hoe, a plow, a tractor in relationship to growing food). My view recognizes that -demand- is, of course, the driver of an economy (because without demand there's no point to any kind of effort), but that supply is the primary indicator of what level of demand (read, consumption) can be satisfied. In my view, any market distortion that leads individuals (and institutions) to believe they can consume more than they -actually- can is problematic. And that's precisely what QE does. How so?
First I'm going to give you a very basic explanation of how QE distorts the market and then I'll give illustrate this with a concrete example.
(4) QE reduces the rate of interest. (5)The problem is that the rate of interest, before government intervention, reflects something real: consumer time preference. If the participants of a market are more eager to save than to consume, then there will be a surge in the amount of savings available. This surge will mean that the rate of interest at which those savings can be loaned out will go down. On the other hand, if the participants of a market of more eager to consume than save, then there will be less savings available for loans and investments and, thus, the interest rate on these loans and investments will be high. The problem is that the fed QE'ing does not fundamentally change the time-preference of the market participants. Thus, surface level change in the interest rate (due to the increase in the money supply) doesn't actually reflect the preferences of the consumers. The result of the incongruity between the rate of interest and the -actual- time preference of market participants is a destructive, inefficient boom-and-bust. This boom-and-bust occurs because investors are relying on the new interest rate for information about consumer preferences when, in fact, they are not getting information about consumer preferences but, instead, are only getting information about immediate changes in the money supply. In short, QE is economically destructive.
To concretely illustrate this process, I'll use your example of the factory. You agreed with me that banks get the money first. The "expectation" is that the banks will invest the new money into new productive enterprises. And this, I believe, is where you should already be suspecting something fishy. Why?
Remember, the fed did not create any new -actual- value. They typed a number into a computer and -bingo- that number became dollars. Obviously you'll agree that the fed could not design a factory in a drawing program on a computer (you know, the kind of program with a "pencil" and a "spray paint" can), print it out and then hope for the factory to magically appear. So how is it that the fed typing in a number and then sending some of those numbers over a wire is going to create a real-life factory?
Well, in essence, QE allows those who first touch the money to be able to build the factory at a reduced price because they've access to the money first (before market prices are able to rise in response to the increased money supply). It's this reduced price, and only this reduced price, that makes the construction of the factory (or whatever venture) economically viable. It has to be this way because if the factory was economically viable -before- the QE, then why did the QE need to happen in order to cause the factory to be built?
Now, critical to your position is the view that once the factory is completed, then it will begin producing goods and, thus, grow the economy. This conclusion is the problem because it focus is too narrow and, as a result, omits the destructive effects caused by the construction of this factory.
The -reason- the factory wasn't profitable before QE was because of the aggregate demand of the consumers in relationship to their income. That is, they may have wanted, say, a newer and bigger flat-screen, but they couldn't -afford- it or weren't willing to choose the flat-screen over -other- values they wanted (house, car, cell phone, shoes, whatever). What the QE has done, though, is make flat-screens cheaper (I'll just stick with the idea that it's a flat-screen factory but it applies to whatever factory you like) because it reduced the price of the factory (via the power of newly created money -before- the market reflects the increase in the money supply via increased prices). At this new, cheaper price, more consumers are likely to choose flat-screens than otherwise would have.
But what else results because of these new, cheap flat-screen tvs? Well, relative to the decrease in the price of flat-screens, other goods are now that much more expensive. Why? Well, if the flat-screen factory was to be built then the materials and the labor had to be bid for on the market. And this means every other are of the market had to pay relatively more for that material and labor. Which means that the prices of goods -other- than flat-screens will go up. So QE has resulted in more flat-screens being produced but, at the same time, less monitors, calculators or whatever else the market would have used those materials and labor for.
Even if this were the end of the consequences of QE, it should be enough to advise against it. That is, why not let consumers dictate what the market produces and not give any institutions an unfair access to newly crated money. Unfortunately, the consequences don't stop here.
Now that more people are buying flat-screens (because of their reduced price) instead of, say, cell phones, a cell-phone factory is no longer profitable (because people are spending their money on flat-screens instead of cell phones). So now the cell-phone factory has to shut down. All the workers get laid off and they must be retrained to build flat-screens.
Further, other individuals and businesses may see the new flat-screen factory churning out tvs and selling them for a profit (a profit made possible by the discounted rate of the capital goods used to create those flat screens). They assume that price//demand relationship for flat screens exists in relationship to the real preferences of consumers (not the discounted-price//demand relationship that -actually- allowed the "profitable" construction of the flat-screen factory), and thus they conclude that they too will be able to profit of the construction of a flat-screen factory. So there is a rush to build flat-screen factories (with a correlating rise in the wages of those that build and work at the factories and the materials used in the production, which means a correlating rise in the price of all those other goods, which means a relative amount of factory closings because of the increased cost of production of, say again, cell phones). Now other investors are seeing the "value" of flat-screen factories as rising. So perhaps they put their money into that area of the market as well. And so on. This is the formation of a bubble.
It's only until the prices in the market reflect the newly created money from the QE does the -real- demand for flat screens become apparent. And it's when this real demand becomes apparent (via decreased demand for flat-screens caused by less willingness to buy flat-screens because of the increased prices [and thus less money to spend on flat screens] of a wide variety of other goods on the market) that the uselessness (read, inefficiency) of the newly constructed flat-screen factories becomes apparent. This is the bust.
And in my understanding, this is precisely what happened in the housing market in the early 2000s. And -this- is why QE (and other interest rate manipulation) is destructive.
Sources:
http://mises.org/journals/scholar/Thornton13.pdf
http://mises.org/journals/qjae/pdf/qjae9_4_4.pdf
In the course of a conversation with a friend, I did my best to understand Quantitative Easing through an Austrian perspective. This was the fruit of that labor and I did my best to convey what I learned using a simple vocabulary. So for whatever it's worth, here you go:
(1)It's true that without "money" the economy would stagnate (bartering is relatively inefficient). But just what" money" is and how it's "value" is determined is, in essence, the entire point at stake because in the case of QE, you have an institution creating, out of thin air, something that is supposed to have value. Unfortunately it can't do this. Yes, it can create the money. But no, it can't create actual values. To understand why it can't do this, you've got to recognize that the only reason markets exist is because things that have value are not free. Anything that's free is not on the market (who would buy something that's free?) Anything that's not free cannot be be magically created, for example, by punching numbers into a computer at the fed. Elaborating on this fact is the bulk or my reply below.
I'm going to start the bulk of my reply by focusing on your conclusion proper. First, if you want me to accept as true your claim that growth in the money supply is necessary for economic growth then you need to explain why that's true (You don't provide an argument, you just state your conclusion). (2) You'll also need to explain why the fed doesn't "print" a trillion-trillion dollars right now to "grow" the economy at a great rate. Finally, (3) in order to differentiate a policy difference between printing 600 billion and a trillion-trillion dollars, you'll need to at least lay out the justification behind the basic methodology used to formulate the "correct" amount of dollars to fabricate.
It seems to me that my task is much easier because my view of what causes growth in an economy is simpler: economic growth is nothing but the result of more profit for the same or less effort. Period (e.g., a hoe, a plow, a tractor in relationship to growing food). My view recognizes that -demand- is, of course, the driver of an economy (because without demand there's no point to any kind of effort), but that supply is the primary indicator of what level of demand (read, consumption) can be satisfied. In my view, any market distortion that leads individuals (and institutions) to believe they can consume more than they -actually- can is problematic. And that's precisely what QE does. How so?
First I'm going to give you a very basic explanation of how QE distorts the market and then I'll give illustrate this with a concrete example.
(4) QE reduces the rate of interest. (5)The problem is that the rate of interest, before government intervention, reflects something real: consumer time preference. If the participants of a market are more eager to save than to consume, then there will be a surge in the amount of savings available. This surge will mean that the rate of interest at which those savings can be loaned out will go down. On the other hand, if the participants of a market of more eager to consume than save, then there will be less savings available for loans and investments and, thus, the interest rate on these loans and investments will be high. The problem is that the fed QE'ing does not fundamentally change the time-preference of the market participants. Thus, surface level change in the interest rate (due to the increase in the money supply) doesn't actually reflect the preferences of the consumers. The result of the incongruity between the rate of interest and the -actual- time preference of market participants is a destructive, inefficient boom-and-bust. This boom-and-bust occurs because investors are relying on the new interest rate for information about consumer preferences when, in fact, they are not getting information about consumer preferences but, instead, are only getting information about immediate changes in the money supply. In short, QE is economically destructive.
To concretely illustrate this process, I'll use your example of the factory. You agreed with me that banks get the money first. The "expectation" is that the banks will invest the new money into new productive enterprises. And this, I believe, is where you should already be suspecting something fishy. Why?
Remember, the fed did not create any new -actual- value. They typed a number into a computer and -bingo- that number became dollars. Obviously you'll agree that the fed could not design a factory in a drawing program on a computer (you know, the kind of program with a "pencil" and a "spray paint" can), print it out and then hope for the factory to magically appear. So how is it that the fed typing in a number and then sending some of those numbers over a wire is going to create a real-life factory?
Well, in essence, QE allows those who first touch the money to be able to build the factory at a reduced price because they've access to the money first (before market prices are able to rise in response to the increased money supply). It's this reduced price, and only this reduced price, that makes the construction of the factory (or whatever venture) economically viable. It has to be this way because if the factory was economically viable -before- the QE, then why did the QE need to happen in order to cause the factory to be built?
Now, critical to your position is the view that once the factory is completed, then it will begin producing goods and, thus, grow the economy. This conclusion is the problem because it focus is too narrow and, as a result, omits the destructive effects caused by the construction of this factory.
The -reason- the factory wasn't profitable before QE was because of the aggregate demand of the consumers in relationship to their income. That is, they may have wanted, say, a newer and bigger flat-screen, but they couldn't -afford- it or weren't willing to choose the flat-screen over -other- values they wanted (house, car, cell phone, shoes, whatever). What the QE has done, though, is make flat-screens cheaper (I'll just stick with the idea that it's a flat-screen factory but it applies to whatever factory you like) because it reduced the price of the factory (via the power of newly created money -before- the market reflects the increase in the money supply via increased prices). At this new, cheaper price, more consumers are likely to choose flat-screens than otherwise would have.
But what else results because of these new, cheap flat-screen tvs? Well, relative to the decrease in the price of flat-screens, other goods are now that much more expensive. Why? Well, if the flat-screen factory was to be built then the materials and the labor had to be bid for on the market. And this means every other are of the market had to pay relatively more for that material and labor. Which means that the prices of goods -other- than flat-screens will go up. So QE has resulted in more flat-screens being produced but, at the same time, less monitors, calculators or whatever else the market would have used those materials and labor for.
Even if this were the end of the consequences of QE, it should be enough to advise against it. That is, why not let consumers dictate what the market produces and not give any institutions an unfair access to newly crated money. Unfortunately, the consequences don't stop here.
Now that more people are buying flat-screens (because of their reduced price) instead of, say, cell phones, a cell-phone factory is no longer profitable (because people are spending their money on flat-screens instead of cell phones). So now the cell-phone factory has to shut down. All the workers get laid off and they must be retrained to build flat-screens.
Further, other individuals and businesses may see the new flat-screen factory churning out tvs and selling them for a profit (a profit made possible by the discounted rate of the capital goods used to create those flat screens). They assume that price//demand relationship for flat screens exists in relationship to the real preferences of consumers (not the discounted-price//demand relationship that -actually- allowed the "profitable" construction of the flat-screen factory), and thus they conclude that they too will be able to profit of the construction of a flat-screen factory. So there is a rush to build flat-screen factories (with a correlating rise in the wages of those that build and work at the factories and the materials used in the production, which means a correlating rise in the price of all those other goods, which means a relative amount of factory closings because of the increased cost of production of, say again, cell phones). Now other investors are seeing the "value" of flat-screen factories as rising. So perhaps they put their money into that area of the market as well. And so on. This is the formation of a bubble.
It's only until the prices in the market reflect the newly created money from the QE does the -real- demand for flat screens become apparent. And it's when this real demand becomes apparent (via decreased demand for flat-screens caused by less willingness to buy flat-screens because of the increased prices [and thus less money to spend on flat screens] of a wide variety of other goods on the market) that the uselessness (read, inefficiency) of the newly constructed flat-screen factories becomes apparent. This is the bust.
And in my understanding, this is precisely what happened in the housing market in the early 2000s. And -this- is why QE (and other interest rate manipulation) is destructive.
Sources:
http://mises.org/journals/scholar/Thornton13.pdf
http://mises.org/journals/qjae/pdf/qjae9_4_4.pdf
This is what comes from a lot of reading and no direct experience. I'll try to go in order of my emphasises, since I'm too lazy to spoiler everything one at a time:
(1) This may have been true when money was pegged to gold, and it really forms the basis to our current system, but since money is just special paper (and increasingly just 0s and 1s in an electronic account), it's based on purely on the confidence that a dollar today will be able to buy you something tomorrow. Who promises that? The governments of the country/monetary union that prints the paper, and by proxy, their central bank. So, yes, central banks can successfully create something that is traded for value.
(2) Because this would destroy the confidence explained in (1).
(3) Ph.Ds at top schools are expensive, and years of experience as an economist are hard to come by. Still, I don't think they can even give you an exact answer.
(4) No. QE is used by the Fed to stimulate economic activity when their primary tool to stimulate economic activity, actually decreasing the fed funds interest rate, can no longer be used because of the zero lower bound. Whether or not the ZLB is imaginary is up for debate, but that's a different topic.
(5) No. It reflects how often the lender expects not to be paid back, the lender's cost of funds, and what the lender's competition is doing.
The rest follows the faulty assumptions outlined above, so I won't go into it. For some reason, I feel the need to dispel this stuff... maybe it's because people start conversations in bars about LIBOL (sic) and how the Fed is "giving" away money. Or how QE is designed to raise interest rates and the life-long economists making these decisions somehow are less qualified than a guy who talked to an Austrian and read a few articles off of Google Scholar. My apologies MEDiA, nothing personal.
This thread is getting me through an absurdly boring seminar.
