Thursday, March 12, 2015

Giving is Easy - Taking is Hard

Despite the occasional satirical joke, I've never had a grave problem with QE. Like many other sober-minded observers, QE, seen in its temporal context, was one of the few available weapons to put a floor under floor asset prices, finance the large counter-cyclical deficits thus preventing the worst of a delveraging-induced revulsion and associated dislocations of unemployment and output gaps, in an otherwise spartan policy armory. The limited policy options were partly due to rates' proximity to the ZLB, partly because of the difficulty in building consensual responses in an acrimoniously-divided polity and, yes, partly because of the moral furore surround culpability four the crisis.

Though my concerns about tin-foil hat hyper-inflationary fears were near-zero, so too were my expectations that QE would be a panacea. QE, was, never going to be a cure-all, but was decidedly positive whatever critics may say - if only for psychological, confidence-boosting affirmation that the authorities would not stand idly by, holding their willies, passively witnessing a liquidationist resolution, however-much Austrian School proponents were hankering for one.

With memories of Japanese premature fiscal withdrawal still fresh, I believe history will see QE2 as a useful example of trying to avoid past policy mistakes, by making sure foundations of recovery were sufficiently strong before modulating countermeasures. In isolation, it will not be judged harshly. QE3, from the start, was seen by many, as more contentious, and I also agree with their reservations. Growth IMO was sufficiently on its way, and would, (again IMO), have continued similarly without further asset purchases. However, seen in the context of Euro jitters, the silly sequester battles, Arab Spring upheavals, QE3 should also be seen as the Fed's attempt to prevent large political uncertainties from systematically undoing the meaningful progress. And while I was, and am, concerned about the embedding of Pavlovian behavior, I believe there was (at least some) merit in their response and we should accordingly throttle our harshest judgements. The alternative outcome will remain hypothetical, but the actual result of continued growth, faster-than-expected fiscal consolidation, straight-line drop in unemployment and emergence of real wage growth is hardly worthy of too-severe recrimination.

Maybe one-day, social scientists will accurately factor-analyze the transmission mechanism. Was it the QE-induced, low rates themselves? the psychological boost of asymmetrical forward-looking asset-price expectations given a newly-communicated floor?; the asset price market values, capital gains and their multipliers resulting from QE?; the multiplier effects of seamlessly funding counter-cyclical government expenditure - both automatic stabilizers and pro-active stimulus?; or was it just the generalized normalization of economic activity by removing fear of A Great Depression and feared Zerohedge-like survivalist dystopia? I invite readers to offer their attributions of choice and associated weight of contribution.

Whatever one's attribution, no one can ignore the obvious cumulative result of QE and its interactions: asset prices far and wide have soared as a result of the policy, creating unimaginably-large "windfalls" to asset-owners through little cause of their own. Attempts should have been to "sterilize" at least a portion of windfalls - through targeted fiscal policy - partly for reasons of fairness and equity, and partly to deter the systemic gaming in speculative leveraged bets upon one-way economic and financial policy.

How quickly investors forget. If you'd asked large asset owners in late 2008, or early 2009: "Would you give up a tranche of the future capital gains in asset prices in exchange for a floor under prevailing prices, and the near-assuredness of significantly higher asset prices in the future?", I am quite sure of the answer, given the widespread systemic fears and paucity of alternatives at the time. Investors, after all, pay 2&20 to HFs and PE for essentially the same (pre-tax) premise. Was not QE effectively the same proposition multiplied across the entire economy? The liquidationist alternative was clearly unpalatable to asset owners, and sub-optimal for nearly everyone else. IF, as the result of a policy directive, you bestow large windfall gains, it would be only fair to harvest a an additional share of those for the Public's Interest, since the goal of QE policy was NOT to further stoke inequality, nor accelerate the growth of fortunes for existing asset owners, but rather to prevent unnecessary liquidation, and deflation so private-sector balance sheet deleveraging could work its course, and to foster stability, so reviving private investment decisions in the real economy. But, as it happens, giving is far easier than taking away - irrespective if you're a welfare deadbeat (not my language) or a leveraged rentier.

Pundits and critics from the right rarely miss an opportunity to point out the inherent difficulty of unwinding government programs and bureaucracy. It is a criticism worth noting. For bureaucracies and organizations often assume lives of their own and wills to survive long-beyond the sell-by date of the problem or policy purpose, defending their mission and rights to exist with intensity and vigor. Once laws are enacted and forces mobilized, introspection is a novelty.

Yet, the same pundits and critics refrain from similarly-inspired criticisms when it comes to the beneficiaries of QE, and the protection of their windfalls. It is baffling. The right, politically, hates QE, and all that it stands for, but surely all of Jim Bunning's or Rand Paul's tirades would have been put to better use to promote some sterilization policy that would ameliorate the less-desirable side-effects, efforts that would not damage their populist dogma (excepting perhaps their relationship with Grover Norqvist)

Asset owners peculiarly act as if such windfalls somehow resulted from their own brilliance. Many, through every over-leveraged fault of their own, were a pubic-hair's breadth away from financial obliteration, saved by US - and I don't mean the United States, but rather you, and I, as representations of the taxpayer, or bag-holder as the ultimate underwriter of newly issued debt. Others - particularly in the tech world and on the left coast - are blind to the benefits wrought by munificence of The People, and the abundant liquidity finding its way into every inane crevice, and spilling over to provide VC's and PE investors exits at multiples unimagined even three years ago. And the "thanks" that all those west-coast libertarians afflicted with self-attribution bias, is to piss on the under-class who serve them, and wish for a Randian offshore tax-haven to insure they share as little as possible with the undeserving multitudes. These gripes are academic, but asset-owners would do well to reflect upon their self-attribution bias.

As a markets person, my concerns with QE (particularly QE3) remain consistent with concerns expressed in the past at one-way CB interventions. That is to say, it likely creates a moral hazard whereby financial institutions and speculators lean on the policy backstop to front-run, lever-up (be it risk-parity; duration, credit), in ways that ultimately create more systemic risk, volatility, sowing the seeds for future dislocation, and likely requirement for public market stabilization [again]. Such hazard is amplified by lack of sterilization. I admit I don't know precisely how it might be implemented, or the optimal boundaries or details, just that fiscal policy deterrents would help diminish some of the negatives to society of one-way unsterilized monetary policy largesse gifted to large asset owners caught in the happenstance of monetary policy.


RCJ said...

Great post - thanks

RCJ said...

Great post - thanks

TheDumbMoney said...

Very nice piece.

I have always viewed the QEs by either of two alternative analogies: 1) The Fed steering the rudder of our economic sailboat towards an inflationist right in the face of deflationary winds pushing us left, to maintain a straight sailing line; and/or 2) a hastily constructed bridge over a depression canyon, over which our economic train passed when the prior canyon opened up just as we were approaching what had seemed like flat land.

However, it's not merely major asset holders who are subject to biases. And all the same risks apply to common folk were think they are geniuses because they were able to refinance a house at 3.75% for 30 years, or whatnot. I share your concerns.

But househeld debt levels have generally dropped, government and Fed policies are preventing massive levering up at major banks at least, and I do think that the crisis was sufficiently bad that a lot of common people will be impacted psychologically enough to save more and do fewer stupid things, at least for awhile. We see that in data large and small, including consumer responses to lower gas prices, which did not result in a spending spree. If a few Ayn Rand devotees in California think they are geniuses, so be it.

Finally, hedge funds as a whole have performed terribly during this time, as so many had an anti-Fed bias, and let their ideology intrude: Paulson's gold fund, and Hussman's non-hedge fund hedge-fund being the most famous. So I think it's easy to overstate how this has been a windfall to the rich, many of whom failed to participate due to ideology. I think many of those who have benefited most were simply 401k owners and pension funds employing less complicated strategies, and ordinary homeowners with decent credit.

In any event, I'll take moral hazard over a liquidationist Austrian utopia of medieval economic self-flagellation and bloodletting, any day.

One thing I would like to see is all of the Democrats who were major Keynesians during this crisis act logically and also support Keynesian reductions in government spending if and when the economy truly booms. I'm not holding my breath. Accordingly, I can't hold it against the Right too much for hating "Keynesian" economics in a near-Depression (destructive though it was), since Democrats only become "Keynesians" on an opportunistic basis.

Anonymous said...

One of the most level-headed musings on QE I've read since that acronym made its way into the world's popular understanding. Great post C! Just as Mellonist liquidationists proved to be wrong (or early?) about QE causing hyperinflation, neo-Keynesians may be wrong/early in lauding QE while ignoring the unintended consequences. My guess is QE1 will prove to have been justified while Operation Twist (Duration QE) and QE3 went overboard. QE2 is a tough call and quite debatable.

My concerns with QE have been and still are three-fold:

1) If the balance sheets of the Fed, ECB, BoJ stay around 30-50% GDP, then QE is still in place even if rates rise. Like Dalio says, what then do we do next recession or panic? This is not exactly a young global expansion/bull mkt.

2) We all know what QE means and the tools with which it can be implemented (Fed, BoJ, ECB thru bonds or SNB, PBoC thru FX), but what does money truly mean if central banks can just conjure it up from nowhere? The history of fiat currency is not pristine and I doubt QE will help in that dept. The odds of a collapse in the post-Bretton Woods fiat regime still might be long, but they have undoubtedly increased significantly during the 2010s.

3) Will the fiscal policy largesse granted by QE to governments prove too hard to resist? Does QE increase the sensitivity of highly indebted, aging economies to low real interest rates? Past regimes of negative real interest rates have not ended well (mid to late 1970s, mid to late 2000s).

As far as I'm concerned, the history books are FAR from being closed on the efficacy and legacy of QE.

braga fan said...

The polity is acrimoniously divided over past and future QE, so it just delays debates over third rail issues like cutting entitlements and property taxes on stocks, bonds and asset managers.