Why has there been so much debate over the Fed’s monetary policy of so-called Quantitative Easing? The simplest answer is that it pits those countries and ideologies that see the world as a zero-sum game—the I Win, You Lose crowd—vs. those who see the world as having enough wealth for everyone, if we would only share more equitably.
In fact, both sides of the debate mirror the Federal Reserve’s twin mandates—encourage maximum growth without excessive inflation. Among the I Win, You Lose crowd are those foreign countries who want to protect their export surpluses—read China, Germany, and Japan primarily—and the wealthiest individuals and creditors (read banks) who want to protect their wealth—i.e., don’t like deficits of any kind because it cheapens the value of their holdings.
Quantitative easing is the Fed’s policy of pushing down interest rates to encourage spending, instead of hoarding. We know that both consumers and businesses are holding onto their cash because of their loss of confidence in those financial institutions that almost brought down Wall Street. Household deposits held in such as banks and money market accounts are up 38 percent to $7.5 trillion over the past six years, according to the Federal Reserve, while banks have excess reserves they are not lending, and corporations more than $1.8 trillion in cash they are not investing.
Bernanke and the Fed Governors are with the Win-win crowd. They maintain that unless we all cooperate, so that the major exporting countries allow their currencies to appreciate, then everyone will be poorer. The U.S. will continue to lose jobs to the cheaper overseas wages of exporting countries, and the exporters won’t divert the resources necessary to develop their own domestic economies.
If China, for example, allowed its yuan to appreciate, goods would be cheaper for its own people, thus raising their standard of living. As it stands today, almost all that is made in China is exported, so China has to worry about inflation, since not enough is produced to satisfy its domestic demand for goods.
“Currency undervaluation by surplus countries is inhibiting needed international adjustment and creating spillover effects that would not exist if exchange rates better reflected market fundamentals,” Bernanke said in a recent speech to the EU.
Chairman Bernanke’s timing may be right. Economic indications have been strengthening going into QE2, gains reflected by two strong back-to-back 0.5 percent gains for the Conference Board's index of leading economic indicators (September revised from plus 0.3 percent). A wide yield spread continues to be the biggest positive though to a smaller degree given declines underway in long rates, declines triggered and furthered by QE2. A rise in money supply, also related to QE2, is an increasingly significant plus. Another central positive is the factory workweek, strength that is likely to continue given the uplift underway in the manufacturing sector.
A rise in the M2 money supply, meaning money that is actually circulating in the economy, is what fuels growth. Because unless this money is put back into circulation—whether as investments in plants and equipment, or consumer goods and services—economic growth stagnates, as we have said.
But right now the M2 supply has risen just 2.8 percent since April, which is why some inflation indexes are at their lowest level in 50 years—since the Labor Dept. has kept records. And the Fed considers this level to be dangerously close to deflation.
The slow growing money supply is probably why the Personal Consumption Expenditure price index rose just 0.1 percent in September after rising 0.2 percent in August. The core rate was flat after nudging up 0.1 percent in August. Year-ago headline PCE inflation held steady at 1.4 percent. Year-ago core PCE inflation fell to 1.2 percent from 1.3 percent the prior month. Both series are below the Fed's implicit inflation target of 1.5 to 2 percent, hence the deflation worries.
So is the Win-Win crowed right? Is there enough wealth for everyone, if we would only learn to share? Dr. Bernanke maintains that those countries who keep their currencies devalued harm their own people, by not allowing them access to a better life. While the developed countries have to increase growth to pay off their debt and find employment for their citizens.
Leaving aside politics, economists such a Robert Shiller believe there is enough wealth for everyone. In his groundbreaking book, The New Financial Order (2003, Princeton U. Press), Dr. Shiller postulates that though incomes are never guaranteed, they can be insured against ones profession. In fact, social security and unemployment insurance are limited examples. If insurance underwriters can calculate the rate of fires for fire insurance, or life expectancy for life insurance, why not that for professions? It is just a matter of accumulating sufficient data, which modern computer technology is now capable of doing. So that an policy can be taken out on one’s earning potential. When it falls below a certain level, insurance payments kick in, as with unemployment insurance.
We even have something that resembles it—the Earned Income tax credit for those earning annual incomes of less than $10,000. European Union countries have developed it even further. We know that enough is produced in the world to feed itself. The question is how to distribute it.
Harlan Green © 2010