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Why “Fed Easing” Will Not Get Us Out Of the Financial Mess We Are In Today

By : Ziad K. Abdelnour| 10 September 2010
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A debate is being played out today in the Fed about whether it should return to the so-called “quant easing” — buying more mortgage-backed securities, Treasury bills, and other bonds — in order to lower the cost of capital still further.

The sad reality is that cheaper money won’t work. Individuals aren’t borrowing because they’re still under a huge debt load. And as their homes drop in value and their jobs and wages continue to disappear, they’re not in a position to borrow. Small businesses aren’t borrowing because they have no reason to expand. Retail business is down, construction is down, even manufacturing suppliers are losing ground.

That leaves large corporations. They’ll be happy to borrow more at even lower rates than now — even though they’re already sitting on mountains of money.

But this big-business borrowing won’t create new jobs. To the contrary, large corporations have been investing their cash to pare back their payrolls. They’ve been buying new factories and facilities abroad (China, Brazil, India), and new labor-replacing software at home.

If Bernanke and company make it even cheaper to borrow, they’ll be unleashing a third corporate strategy for creating more profits but fewer jobs and a spree of company mergers and acquisitions…..good for Wall Street for sure.

Remember your economics courses back in college if you ever took any? When an economy is very slack, cheaper money is not going to induce much in the way of real economy activity.

Unless you are a financial firm, the level of interest rates is a secondary or tertiary consideration in your decision to borrow. You will be interested in borrowing only if you first, perceive a business need (usually an opportunity). The next question is whether it can be addressed profitably, and the cost of funds is almost always not a significant % of total project costs (although availability of funding can be a big constraint).

So cheaper money will operate primarily via their impact on asset values. That of course helps financial firms, and perhaps the Fed hopes the wealth effect will induce more spending. But that’s been the same pathetic movie of the last 20+ years, and Japan pre its crisis, of having the officialdom rely on asset price inflation to induce more consumer spending, and we know how both ended.

But (to put it charitably) the Fed sees the world through a bank-centric lens, so surely what is good for its charges must be good for the rest of us, right? So if the economy continues to weaken, the odds that the Fed will resort to it as a remedy will rise, despite the evidence that it at best treats symptoms rather than the underlying pathology.

As I pointed it out in one of my recent blogs:

“Deficit doves” – i.e. Keynesians like Paul Krugman – say that unless we spend much more on stimulus, we’ll slide into a depression. And yet the government isn’t spending money on the types of stimulus that will have the most bang for the buck: like giving money to the states, extending unemployment benefits or buying more food stamps – let alone rebuilding America’s manufacturing base.

Keynes implemented his policies in an era of much less debt than we have today. We’re now bankrupt, with debt levels so high that they are dragging down the economy.

Even if Keynesian stimulus could help in our climate of all-pervading debt, Washington has already shot America’s wad in propping up the big banks and other oligarchs.

Keynes implemented his New Deal stimulus at the same time that Glass-Steagall and many other measures were implemented to plug the holes in a corrupt financial system. The gaming of the financial system was decreased somewhat, the amount of funny business which the powers-that-be could engage in was reined in to some extent.

As such, the economy had a chance to recover (even with the massive stimulus of World War II, unless some basic level of trust had been restored in the economy, the economy would have not recovered).

Today, however, Bernanke, Summers, Dodd, Frank and the rest of the “big boys” haven’t fixed ANY of the major structural defects in the economy. So even if Keynesianism were the answer, it cannot work without the implementation of structural reforms to the financial system.

A little extra water in the plumbing can’t fix pipes that have been corroded and are thoroughly rotten. The government hasn’t even tried to replace the leaking sections of pipe in our economy.

Bottom Line:

Fed easing can’t and won’t patch a financial system with giant holes in it.

What’s needed has been obvious to us for years:

Break up the big banks, prosecute the criminals whose fraud caused the financial crisis, and restore the rule of law and transparency.

Until those basic steps are taken, nothing else will work to fix our broken economy…..You wait and see.

Time for a real clean up starting with Congress in November

Your feedback as always is greatly appreciated

Thanks much for your consideration


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  2. Jeffrey L. NelsonJeffrey L. Nelson

    Your writing is full of good thinking and reality. I’ve felt that if stimulus was needed, at least much of it should have been distributed to individuals. Hopefully, people would have spent money on needed “goods and services” to help recharge the economy and save some jobs, and debt reduction. The idea being that to the extent banks/lenders received money reducing or retiring a debt, and thereby losing interest and fee income, banks would be working hard to make new loans to regain those earnings.

  3. Faisal A. MubaideenFaisal A. Mubaideen

    You covered all what we are thinking about. As aformer industry and manufacturing man I like to also reconfirm that we in America need to refurbish and rebuild our manufacturing base, I think if we do that the whole economy will flourish. Hope we can build more on this discussion. Thanks again Mr. Zias

  4. T. Craig EschrichT. Craig Eschrich

    Ziad, while I agree with what you have said, I also believe that there are far more complex issues in play that make the Feds decision making process much more dynamic than what either of us will be able to address here. I seriously doubt a Republican or Democrat would agree on what should be done, but neither would take a position just to be contrary or for the prerogative to simply be wrong on their own terms because they can….I think they each do what they do trying to do the best they can within their own philosophical construct. Fed easing was never calculated to patch the financial situation, it is part of a patchwork and contributions that go to the “patch” but it is not THE patch per se…..and I am sure they know that from all I have heard from both sides of the isle. I would agree with the criminal prosecution things from OUR perspective, but the people in power, both Republican and Democrat will never go that route….it is not in the nature of the political beast to do what is RIGHT in some moral sense…. it does what is right in the POLITICAL sense and that you can take to the bank! The political leaders on both sides will never clean this up as an institutional force…it is not in their political best interest to do so. Anyone that thinks otherwise is deluding themselves. All they will do is tackle the problem differently not any better. If they had an inclination to do what needed to be done they would have all rushed headlong into embracing term limits! The only thing that will improve the economy is the embrace of new apolitical economic theories and business modeling and underlying philosophy. None of which has anything to do with changing political horses from Democrat to Republican or vice versa. If we continue business as usual it will eventually right itself, it always does, but it will simply take longer and that is in fact what is going to happen, mark my words.

  5. Sune Hojgaard SorensenSune Hojgaard Sorensen

    Great article as always my friend! A couple of nuggets that I took away; “Unless you are a financial firm, the level of interest rates is a secondary or tertiary consideration in your decision to borrow. You will be interested in borrowing only if you first, perceive a business need (usually an opportunity).” – This passage explains why cheap money and ‘smoke and mirrors’ will never fix the problems currently facing the world. “A little extra water in the plumbing can’t fix pipes that have been corroded and are thoroughly rotten. The government hasn’t even tried to replace the leaking sections of pip in our economy.” – Perfect illustration of the situation at hand! The following passage is from Wikipedia: Quantitative Easing: “The term quantitative easing (QE) describes a monetary policy used by central banks to increase the supply of money by increasing the excess reserves of the banking system. This policy is usually invoked when the normal methods to control the money supply have failed i.e. the bank interest rate, discount rate and/or interbank interest rate are either at, or close to, zero. A central bank implements QE by first crediting its own account with money it has created ‘ex nihilo’ (“out of nothing”). It then purchases financial assets, including government bonds, mortgage-backed securities and corporate bonds, from banks and other financial institutions in a process referred to as open market operations. The purchases, by way of account deposits, give banks the excess reserves required for them to create new money, and thus a hopeful stimulation of the economy, by the process of deposit multiplication from increased lending in the fractional reserve banking system. Risks include the policy being more effective than intended, spurring hyperinflation, or the risk of not being effective enough, if banks opt simply to pocket the additional cash in order to increase their capital reserves in a climate of increasing defaults in their present loan portfolio.” This whole segment includes a number of rather scary terms used with a rather nonchalant approach, specifically when this man is heading out the decision making process: http://www.youtube.com/watch?v=HQ79Pt2GNJo

  6. AndreiAndrei

    Ziad, You are right that a fed driving banks to lend more for cheaper rates will do little to stimulate the economy. The key to economic recovery in the US is making people believe they have more money with greater purchasing power. The fed “easing” policy, and the desperate “Stimulus” programmes which don’t stimulate the right thing (job creation, confidence in a sustainable recovery etc.) will continue the recession, and the devaluation of the US Dollar, increase inflation/stagflation. The only remaining credible fiscal and financial strategy is for a RADICAL TAX CUT, both on corporations and individuals. A tax cut will provide the added money for people to save or spend (saving increasing bank capital, allowing for cheaper lending in larger amounts), Increased spending will stimulate consumption and demand, creating jobs. What of the deficit you ask… Well, a radical cut in the waste by government will help reduce the deficit, but not eliminate it. The costly and lame Health Insurance Bill should be postponed until the US has eliminated its deficits, and can afford such a wasteful and inefficient programme. And there are so many more areas where costs can be reduced, and productivity in delivery of service improved. The National deficit and debt will rise for 2-3 years as a result of the tax cut, but with the economy recovering through renewed confidence and increased spending, without devaluing the USD purchasing power, and creating an inflationary wave, the chances of moving into surplus, and reducing significantly the national debt are much greater than the myriad of stimulus ill thought out programs. Remember Paul Volker and Reagan after Carter? Where are the leaders with balls that will need to take the hard decisions no-one else in this administration seems to know or can take?

  7. Dave KingDave King

    All good points Ziad. Keynesianism is a bankrupt philosophy that keeps being trotted out by the left because it is the only answer they have that affirms their basic belief that rich people are the problem. They have bought into the class warfare ideology hook line and sinker. Therefore it is not bad policy that is causing fear and uncertaintly in the markets – it is those nasty rich people holding all the money back from investment to spite the poor and stick it to the left. For the true believers it is never a bad idea to raise taxes on the rich – never mind that most successful small businesses which are the bedrock of the economic engine qualify as ‘rich’. Never mind that jobs are going by the wayside in droves. It is just ‘fair’ that we tax the rich and pay for the union pensions and the big expansion of bureaucratic positions in federal government. We are trending toward government of the government by the government and for the government. The biggest threat to our way of life is debt to pay for it all. The debt has in the last 60 years eaten our prosperity in the form of monetary inflation. It will only get worse with the policies that this administration continues to pursue. Unfortunately it is very unclear that there is enough political will in this country to address this issue. It is one thing to seek a short term relief to the effects of recession – it is a wholly different thing to endure the long term sacrifice and hardship necessary to wring out the underlying systemic problems that face out country due to the corruption of our political class and the fundamental failure of leadership and moral rectitude at all levels. My parents sacrificed so their children could have a more prosperous life than they had. The current generation will seemingly accept no sacrifice even if it means condemning their grandchildren to a life of servitude. That is where we are heading with the levels of debt that we now have. Unfortunately the voting public are just like frogs in warm water. They know the temperature is rising but they cannot bring themselves to accept any pain at all in order to turn back the dial and get things going the other way. The late great Jack Kemp said it this way ‘They want to create an economic desert and hand everyone a glass of water’. So far it is working. When they have succeeded in creating a great depression from a recession, they will blame wall street, greedy ceos hiring offshore workers, conservatives, and talking heads and everyone else that doesn’t agree with their bankrupt policies and there will always be at least 30% of the people who will agree. Amazing.

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