The Bank of Japan’s Quantitative Easing: An Unnatural Imbalance

On October 31, 2014, the Bank of Japan made public its policy of buying larger amounts of government debt—80 trillion yen ($734 billion) a year—so as to stimulate the economy.[1] The Nikkei 225-stock index average rose almost 5 percent that day, while the yen fell to its lowest level against the dollar since the preceding month. In effect, investors and analysts were factoring in the likely stimulatory impact on the economy and the inflationary implication of more yen relative even to the expanded output, respectively. Put another way, the lower yen suggests that any strengthening of the currency from higher economic output would be more than countered by the weakening impact of inflation. Interestingly, not even the likely boost to exports from the cheaper yen was expected by the market participants to give the stimulus the edge in pushing the currency higher rather than lower.

 

I submit that the central bank’s strategy is suboptimal in terms of the mission to stabilize the currency on account of the risk of an inflationary spiral. The imprudence, or imbalance in favor of stimulus, stems from another imbalance wherein exaggerated fears of deflation are allowed to eclipse the common-sense notion that periods of deflation naturally go alone with there being periods of inflation. The problematic mentality, I contend, can be understood in terms of a wave function wherein only the half of each wave above the base line are permitted. Such a policy goes against the nature of a wave function to spend as much time below the line as above it. In monetary terms, price stability is thwarted in favor of an inflationary bias.

 

I suspect the root of the problem involves a failure to distinguish between moderate, or cyclical deflation and the severe, ruinous kind. The lack of balance involved in resolutely shutting off even low deflation after years of inflation can resonate into an economy being out of balance. That is to say, the imbalance can expand like a ripple in a pond—a ripple being of course a natural wave function of ups and downs rather than only ups. Perhaps applying principles of natural science to macroeconomics might help central bankers in their task to maintain price stability.

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[1] Jonathan Soble, “Japan’s Central Bank Unexpectedly Moves to Stimulate Economy,” The New York Times, October 31, 2014.

On the Federal Reserve’s Quantitative Easing: Impacts on the U.S. Debt and Inflation

With government-bond purchases of $3.9 trillion (including mortgage-backed bonds) from November 25, 2008 to October 30, 2014, the U.S. Federal Reserve Bank stimulated the American economy by keeping interest rates low. This in turn kept the U.S. Treasury department’s interest payments on the gargantuan federal debt lower than would have otherwise been the case. Put another way, the Federal Reserve Bank’s massive foray into stimulating the economy made holding debt and borrowing still more money less costly than it would otherwise have been, and thus enabled the government’s penchant for debt-financing over raising taxes and/or reducing spending. “Enabling an addict” would be a less charitable way of putting the Fed’s role vis-à-vis the U.S. Government. In this essay, I explore problems resulting from the Fed’s stimulus on the government’s debt-financing.

The central bank created the $3.9 trillion (less reinvested principal and interest payments received) out of thin air—increasing the number of dollars relative to economic output. The implied inflationary impact was hidden by the lack of demand-pull inflation during the recession and even the recovery, given the stationary income level and the relatively few new, full-time jobs created. Cost-push inflation was also low, with oil prices in particular dipping in 2014. In spite of Janet Yellen, the Fed’s chair, being worried more about deflation than inflation (as if years of piled-on low inflation should not naturally be balanced by years of low deflation), I am reminded of the interest-rate hikes that Fed chair Paul Volcker instituted in 1981 to squeeze years of high inflation out of the system.[1] Unlike cost-push and demand-pull inflation, more dollars chasing relatively less goods—even when the economy is growing—is bound to give rise to inflation at some point.

More troubling yet even more subtle, the Fed’s creation of dollars to buy treasury bonds means that the Treasury Department does not have to pay as much in interest as it otherwise would because the interest rates are lower. Congressional legislators and the president have in turn been more inclined than they otherwise would have to go the route of borrowing even more; for not only is the cost of borrowing less, they knew the Federal Reserve Bank would create money to buy treasuries. This feedback loop is inherently bad, both in terms of political economy and ethics.

First off, although the Federal Reserve is an independent federal agency, it is part of the federal government. Created by an act of Congress, the central bank can come to rescue of the U.S. Treasury Department but not those of the Union’s states (unlike the ECB in the E.U.). So a conflict of interest is exploited when a Fed chair decides to create money to finance (or lower the cost of) the government’s debt. Imagine what would happen if a person could create money to pay for food such as ice-cream and cake. It would be too tempting for the person to eat too much—his or her self-maintenance role would likely succumb to his or her pleasure-seeking role. Taking the Fed as federal institution, the conflict of interest lies in two or more such institutions, including the Fed, essentially colluding to get free (or reduced cost) debt. A scenario in which Congress and the president want to borrow $1 trillion and the Federal Reserve simply creates the money and sends it to Treasury.

One way the Federal Reserve can partially deconstruct the conflict of interest and reduce the chance of inflation is for the central bank to destroy rather than hold or reinvest the returned principal (and interest revenue less costs) when the bonds come due.[2] Ideally, all of the money that the Fed created for its Quantitative Easing program should be destroyed. To be sure, even temporarily creating money to buy treasuries makes it easier than would otherwise be the case for Congress and the White House to borrow. With an accumulated debt of around $17 trillion, the U.S. Government was already over-extended beyond the point of no return. For the Federal Reserve to create money to buy government bonds may only compound the quagmire even if the economy is stimulated in the short run. Examining these more subtle implications can thus potentially enhance the ability of the popular sovereign—the People—to keep the federal government from heading down a ruinous path.

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[1] John Waggoner, “Easy Come, Easy Go: Beginning of the End,” USA Today, October 30, 2014.

[2] Darrell Delamaide, “A Pat on the Back for Yellen—But Lots of Hurdles Ahead,” USA Today, October 30, 2014.

On the Credibility of the E.U.: Transfer Payments and State Deficits

In October of 2014, the prime minister of the E.U. state of Britain blatantly (and quite publically) refused to pay a “bill” that the E.U. Commission charged the state on account of upward revisions of its economic growth. “We won’t pay it,” David Cameron said defiantly into a microphone. Meanwhile, Jyrki Katainen, the E.U. commissioner for economic and monetary affairs, accepted the draft budgets of the states of France and Italy even though they violate the limit of 3% of GDP in the European Growth and Stability Pact. Those two states could face fines, however, and the commissioner also noted that the budgets would face strict scrutiny. I contend that these instances of tension between the state and federal levels speak volumes as to the attitude of state officials and likely their constituents toward the E.U. itself. The attitude does not bode well for the European Union as a system of public governance. 

The full essay is at "Essays on the E.U. Political Economy," available at Amazon.

Is Daily Sustenance a Human Right?

Should healthcare, foodstuffs, and shelter be treated as commodities subject to the buyer’s ability to pay, or designated as rights because a person’s survival depends on them? In short, is the innate human drive of self-preservation worthy of being recognized societally as justifying a right to sustenance? In the E.U., this point of view tends to hold sway, whereas in the U.S., food, medical care (and medicine), and housing units tend to be treated as commodities subject to a buyer’s ability to pay. This difference in political socio-economic ideology is as telling as it is significant, yet in the U.S. at least the question is rarely debated directly rather than through ancillary issues.

Here is one American politician’s rather direct articulation on the campaign trail of the “commodity,” or “non-right” position:

“We’re looking at Obamacare right now. Once we start with those benefits in January, how are we going to get people off of those? It’s exponentially harder to remove people once they’ve already been on those programs…we rely on government for absolutely everything. And in the years since I was a small girl up until now into my adulthood with children of my own, we have lost a reliance on not only our own families, but so much of what our churches and private organizations used to do. They used to have wonderful food pantries. They used to provide clothing for those that really needed it. But we have gotten away from that. Now we’re at a point where the government will just give away anything.”[1]

The dependence argument and the related perspective that a government gives things away in its entitlement programs both assume that the beneficiaries do not have a right to sustenance materials, or that the stuff provided goes beyond necessities. Furthermore, the “charities” preference over government also assumes that sustenance is not a right, for charities unlike government are not geared to providing items to cover each day.

Just as a market cannot be relied on for a daily provision because procurement depends on having enough money at the time of purchase, so too charities cannot be relied on to provide clothing and food for people such they will not go without for even a day. The possible discontinuity is accepted, according to this view, because sustenance is not something that people should treat as a given; rather, a person’s continued day-to-day survival naturally depends the person’s ability to work. The assumption here is that a lack of work is likely due to some problem in the person, rather than a macro problem in the political economy. Individuals are not victims of a feature of societal organization, such as an economic system, so no right to unconditional compensation is recognized. Besides, charities can pick up the slack—daily sustenance not being a legitimate demand.

Put another way, the moral or religious obligation of the well-off to donate part of their surplus to charities is assumed to cover the occasional short-fall in food and clothing from being laid off in a recession. The moral obligation extends to helping even those people who have lost work due to their own fault, but the expectation is that if they want to survive beyond a temporary period of job-looking, they should rely on their own means of earning enough money to provide for themselves.

My point here is that in not being thwarted by the incendiary “getting free stuff” remark, readers of Joni Ernst’s remarks can know the assumptions behind her ideology and evaluate them. If enough people do so, then perhaps those assumptions can be debated in societal discourse. A societal consensus on the assumptions would ideally lead to the associated public policy being enacted. In other words, the assumptions that most people in a geographical region hold can be made transparent to them such that critical reflection can occur both individually and societally. From such recognition and thought, greater confidence can be had that people really do believe as they do regarding the assumptions, which involve subjective value-judgments rather than being solely based on fact.

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1. Jonathan Chait, “Republican Joni Ernst Admits Why Republicans Really Hate Obamacare,” New York Magazine, October 16, 2014.

Stifling Change: Columbus Day and Thanksgiving

In Canada, Thanksgiving is celebrated at harvest-time, on October 12^th, rather than a week before the first month of winter in the Northern Hemisphere. For the States south of Canada, whether their respective peoples are cold or warm on the third Thursday in November, the holiday’s date is etched in stone, given the illustrious aura of the U.S. president who had enshrined the date in the midst of a horrendous war between the USA and CSA in the 1860s. Few people would dare even entertain the natural assimilation of Columbus Day and Thanksgiving Day on October 12^th. So, well after harvest in most of the States and bunched in with Christmas and New Years—effectively ridding the latter of any left-over enthusiasm—people in the States in the northern climes are consigned to stuff themselves like Turkey birds while the surviving natural turkeys shiver outside. Human nature itself may be hardwired against change, and the massive scale of modern political association may exacerbate the paralysis.

Early October in 2014, the Seattle City Council voted unanimously to replace Columbus Day with “Indigenous People’s Day” as a city holiday, even though Columbus Day would still be celebrated locally as the federally-recognized holiday. Seattle councilman Bruce Harrell explained that he had co-sponsored the resolution because he believed that the city would not be successful in its programs and outreach to Indians until “we fully recognize the evils of our past.”[1] One local resident took offense at an Indigenous People’s Day “coming at the expense of what essentially is Italian Heritage Day.”[2] However, because Columbus was part of a Spanish expedition, Columbus Day is not “essentially” an “Italian Heritage Day.” Rather, the holiday remembers back to the time of Spanish power. It follows that the resistance to the change in Seattle was overblown.

The “indigenous People’s Day” label is itself problematic, as American Indians “only” came to the continent about 15,000 years ago—not long at all for a species that has been around for 1.8 million years. The thorny issues could be obviated simply by moving Thanksgiving from the crowded year-end field of holidays to October 12^th at harvest-time in many of the States. That this change would seemingly ruin the “holiday season” as it has always been and undo the order penned by the iconic Abraham Lincoln pinning Thanksgiving to the third Thursday in November suggests that the chances of moving the holiday are slim to nil even though having Thanksgiving so late (and so close to Christmas and New Year’s) is arguably suboptimal.  

Compounding the problem with effecting change in the U.S., the increasing political consolidation at the federal level stymies a societal change through legislative means because more political energy must be amassed. The “one size fits all” assumption does not help. Even though Seattle can safely contemplate two holidays on one day, the sheer possibility of Thanksgiving being in October in some States and in November in others would likely trigger fears of disunion.

 In the E.U., the subsidiarity principle urges that legislation be done at the lowest practicable level of political organization; in the U.S., the Tenth Amendment seeks to forestall political consolidation at the expense of federalism. As Seattle attests, Congress need not have such a choking power-monopoly on holidays, and Americans need not be so afraid and thus over-reactive as proposals see the light of day.

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[1] Phuong Le, “Columbus Day in Seattle Replaced with a New Holiday,” Associated Press, October 6, 2014.

[2] Ibid.

Political Protests in Hong Kong: The Market Overreacts

Geopolitical risk is essentially uncertainty to the market. Given the nature of human fear, the psyche can add a “multiplier effect” to an objective calculation of uncertainty. Just as we are naturally so close to human nature that its most ubiquitous tendencies eclipse our notice, so too do we tend to assume that the market’s assessment of a political risk is accurate, given the efficiency and effectiveness of the stock market. The market’s initial reaction to the political protests in Hong Kong in September 2014 may demonstrate that the market’s participants even routinely overstate both the probability and severity of the downside of a mass political event.

Under China’s “one country, two systems” accommodation of Hong Kong’s free market and democratic past, the semi-autonomous nature of the former British colony was presumably at risk as young adults protested Beijing’s decision to have a panel select three candidates to run for chief executive of Hong Kong in 2017. When the British returned the colony to China in 1997, the Chinese Government had promised that the post would again be elected democratically. To the protesters in 2014, the empty promise was a betrayal that could be read as a baleful sign of what life would be like under the rule of Beijing.

As though a knee-jerk reaction to the sight of large crowds taking to the streets in Hong Kong, stocks of companies having significant operations in or through Hong Kong lost value on the New York Stock Exchange on September 29, 2014. Iao Kun, for example, lost 6 percent, while Exceed lost 3.6%, Bonso Electronics lost 3.1%, and Global-Tech Adv. Lost 3 percent.[1] “Markets are jittery because anything that threatens Hong Kong’s status as a one country, two systems place could (affect) the world economy,” said Rod Smyth, chief investment strategist at Riverfront Investment Group.[2] I’m not convinced by this reasoning.

Firstly, Chinese communism had already come to embrace the government-influenced “free” market, so it does not follow that squashing the political protest would imperil firms in Hong Kong; it is not as if the private property would be grabbed by the government. Secondly, Beijing had a strong economic incentive at the time not to compromise Hong Kong as an economic engine. Ignoring this point, investors in the New York stock market overlooked the ability of Chinese officials to put down the protest without necessarily touching businesses in Hong Kong. That Beijing had the strange (to Western ears) fear that Hong Kong’s political freedoms would “infect” the rest of China does not translate into a fear that Hong Kong’s wealth might also “infect” other cities—as if too thriving cities would be a bad thing.[3]

Smyth claims the big “risk is this thing [i.e., the protest] escalates and China starts to get mad at protesters and comes in with a heavy hand and changes other things.”[4] The vagueness in this residual is itself an invitation for investors and stock analysts to extrapolate imprudently—which is to say, without much of an innate sense of the threshold beyond which lies blind fear tripping over itself ad infinitum. What things exactly? This question invites an orgy of uncertainty. Even if Hong Kong were to lose its semiautonomous status in China, it does not follow that Beijing would turn the city upside down. Rather, the objectionable political protests would likely result in modest political-only changes—keeping in mind China’s stake in Hong Kong’s role in the global economy. After all, even as semi-autonomous, Hong Kong cannot elect its chief executive freely. How much autonomy did Hong Kong have in 2014 that it would lose? The market’s initial reaction is not based on business fundamentals, but, rather, on irrational uncertainty.

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[1] Adam Shell and Kim Hjelmgaard, “Hong Kong Protests Buffet Markets,” USA Today, September 30, 2014.

[2] Ibid.

[3] Calum MacLeod, “’Umbrella Revolution’ Opens Wide,” USA Today, September 30, 2014.

[4] Shell and Hjelmgaard, “Hong Kong Protests.”