Thursday, July 16, 2015

QE For The People - What Could Go Wrong?

A number of economists propose in the FT to implement what has been dubbed "QE for the people".
They start off quite well, noting:
"The evidence suggests that conventional QE is an unreliable tool for boosting GDP or employment. Bank of England research shows that it benefits the well-off, who gain from increasing asset prices, much more than the poorest."
As is often the case with these things, they go on to propose something even worse than what's already being implemented:
"Rather than being injected into the financial markets, the new money created by eurozone central banks could be used to finance government spending"
Government spending already benefits from QE at the moment. Since Draghi's announcement, Italian and German borrowing costs have dropped. And then we haven't even discussed all the other ways the ECB has found to prop up sovereigns, such as the cheap LTRO loans to banks, who channeled the money through to governments, especially in Spain and Italy. This is so well-known that it was called the "Sarkozy trade" - a term adopted by markets after the French president suggested that governments urge banks flush with ECB cash to buy their bonds. So why try more of the same?
Those calling for a "political Europe" should take notice that large-scale transfers have already been implemented within the Eurozone since 2010, through the EFSF, ESM and primarily (German economist Hans-Werner Sinn estimates to the tune of 75%) through the ECB. When one receives a loan with an interest rate which is lower than the market level, one receives a gift, in economic terms.
The economists argue that "mixing monetary and fiscal policy" isn't a problem because "traditional monetary policy no longer works".
They must have missed the alternative of Austrian economics. Post-World War II Germany and its relatively strict hard money policies can perhaps be instructive for a model that has been tested. Japan has been trying excessively loose Keynesian monetary policies after its bust around 1990, withnegative results. But the authors seem to prefer to apply the principle "When in trouble, double".
A particular problem with financing governments through the printing press is that Parliaments are being bypassed, exactly the reason why politicians  prefer to let Mario Draghi do the brunt of the dirty work in the euro crisis.
I hope it doesn't come as a shock to anyone, but my suggestion is the following: governments should be funded by taxes alone, democratically controlled through Parliaments. Ideally these taxes should consist in one invoice per citizen, detailing the services received. Perhaps socialists may want to add a “solidarity” invoice to rich people, raising funds which can be transferred on in a transparent way to those perceived to be in need. Clearly this system is way too transparent for the sake of any political purpose and would mean the end of a whole industry of tax advisors, but perhaps it may one day serve as a model for any future new country.
An alternative put forward by the authors which goes to the heart of their "QE for the people" - proposal is the following:

"Each eurozone citizen could be given €175 per month, for 19 months, which they could use to pay down existing debts or spend as they please. By directly boosting spending and employment, either approach would be far more effective than the ECB’s plans for conventional QE"

Why be so modest and only give €175 per month, someone may suggest? However, money shouldn’t be manipulated to support economic growth. On the contrary, manipulating its value will create uncertainty and hurt economic growth.
One could compare money to a voucher in a cloak room. If Sophie has received a voucher in exchange for storing her jacket, she wouldn't exactly like it if Mario Draghi, the manager of the cloak room, gives a voucher to his girlfriend, Angela, without asking her to put up some collateral. Whereas people would know that Sophie's voucher is backed by value (her jacket), her voucher would lose value in case the voucher-supply would be increased  artificially, to the benefit of the cloak room's manager's friends.
Shall we then see hyperinflation? Warnings of hyperinflation have been wrong in the past, and some Austrian-leaning economists like Mish have beencountering warnings from their Austrian friends.
Our monetary system is still not completely controlled by governments. After a central-bank induced bubble has bust, like in 2008, when one would expect prices to go down again after they have been rising in an unsustainable way, monetary pumping still may not be sufficient to counter deflationary forces. On the other hand, even modest printing may result in hyperinflation in case citizens lose trust in currency managed by the government, or if for example a remarkably solid alternative currency emerges and becomes popular, despite the fact that one needs to use government currency for contracts and taxes (let me disclose I have my doubts whether bitcoin will ever fulfill this role, but it certainly has proven to be able to circumvent capital controls).
In other words, the proposal to give each eurozone citizen €175 per month may not unleash hyperinflation, but it may counter certain natural deflationary forces, such as those in Spain, where the euro and its easy money fueled a toxic real estate bubble which left the banking system full of bad debt after it busted. If this proposed flow of "helicopter money" would effectively be injected and prop up prices, Spanish entrepeneur Conchita may decide not to open her sandwich place after all, given how rent prices would remain too elevated.
That's not to say that in all circumstances it would be wrong for Central Banks to increase the money supply. In a system where money would be entirely private, the market may still opt for a system whereby the monetary mass increases in case value is created (after innovation, for example) and decreases in case value is destroyed (after natural disasters, investment bubbles or wars, for example). Going back to the example of the cloak room, it's obvious that more vouchers are needed when new people arrive with jackets. If the government takes over the money supply from the private sector, as it has done everywhere, it should attempt to mimic what would happen in a scenario of private money.
In the case of Spain, that apparently means allowing deflation. I have understanding for those who claim that it's just madness to allow deflation in such a highly (privately) indebted country, but if that is true, it probably means we need to look at how to best organise defaults, rather than distorting decisions regarding saving and investing through manipulation of the value of money, as the authors propose. In the case of Spain, that means restructuring the banking system, something which has been done to a certain extent, with the help of a 40 billion euro bailout, but clearly not sufficiently, given the high amount of remaining bad debt. In the case of the whole eurozone, it means looking at alternatives to the current, dysfunctional currency union.
Given the massive mistakes which were made by central banks from Weimar to Bernanke and the relentless attempts to use the printing press to finance governments (after all, the Bank of England was set up to finance the King's wars), it probably shouldn't take much to convince people of alternatives, and not more of the same, right?