Sophisticated economics

Lest you be under the impression that the Federal Reserve is in control of anything, consider this informal Q&A with Ben Bernanke:

RUHLE: … you recently had dinner with Ben Bernanke. What went down? We didn’t get to be there.

EINHORN: Well, it was — I watched him for years in front of Congress and speaking and watched him on TV and “60 Minutes” and —

RUHLE: And what was your opinion of him before you had dinner?

EINHORN: I was — I’ve been critical. I’ve been critical of him for a very long time. And the dinner for me, in one way it was cathartic because I got to ask him all these questions that had been on my mind for a very long period of time, right? And then on the other side, it was like sort of frightening because the answers weren’t any better than I thought that they might be.

SCHATZKER: What did you ask him?

EINHORN: I asked several things. He started out by explaining that he was 100 percent sure that there’s not going to be hyperinflation. And not that I think that there’s going to be hyperinflation, but it’s like how do you get to 100 percent certainty of anything? Like why can’t you be 99 percent certain and like how do you manage that risk in the last 1 percent? And he says, well, hyperinflations generally occur after wars and that’s not here. And there’s no sign of inflation now and Japan’s done a lot more quantitative easing than we’ve done, and they don’t have it. So if there is a big inflation, the Fed will know what to do. That was kind of the answer.

RUHLE: What did you say?

EINHORN: That was it. Then it went to the next question. So then a few minutes later it came back and I got to ask him about the jelly donuts. And my thesis is that it’s like too much of a good thing. Like lowering rates and quantitative easing and these stimulative things, they help but with a diminishing return. And eventually you go too far and it’s like eating the 35th jelly donut. It just doesn’t help you. It actually slows you down and makes you feel bad. And my feeling has been that by having rates at zero for a very, very long time the harm that we’re doing to savers outweighs the benefits that might be seen elsewhere in the economy. So I got to ask him about this.

SCHATZKER: Okay, and what did he say?

EINHORN: Well first of all he says, you’re wrong. That it was good. And then he said the reason is if you raise interest rates for savers, somebody has to pay that interest. So you don’t create any value in the economy because for every saver there has to be a borrower.

And what I came back to him was I said, but wait a minute. You said for a long time we haven’t had enough fiscal stimulus, and who’s on the other side of the low interest trade? It’s the government. And so if the government — if we raise the rates, the government would have to pay more money to savers. You’d have the bigger deficits. You’d create the stimulus, the fiscal stimulus that you’ve been complaining that Congress wouldn’t give to you, right? And savers would benefit from the higher rates and because savings is spent at a very high rate in terms of interest — interest income on savings is spent at a high percentage, you’d get a real flow through into the economy.

It gets incredibly tiresome hearing these idiot Keynesians – and yes, monetarists are Keynesians – constantly reminding everyone that for every buyer, there has to be a seller. Although Bernanke’s formulation is technically incorrect, as there does NOT have to be a borrower for every saver because not all savers are lenders.

We can cut him some slack on that; it was an informal conversation and since the discussion concerned interest rates, only savers who are lenders, (which is to say depositors), were in context here. But what we cannot cut him any slack on is the idea that this statement of the obvious actually addressed the issue.

The real reason there isn’t a risk of hyperinflation is the same reason rates have been keep artificially low for years: we are in an ongoing state of credit disinflation. All that cheap credit has gone into the banks and the equity markets to prop them up, but as Einhorn has noted, the law of diminishing returns is beginning to take effect.

Karl Denninger explains the problem with quantitative easing:

The basic economic equality is MV = PQ; that is, “Money”(ness) X Velocity (times each unit of “moneyness” is spent in a given amount of time) = Price (of each item or service produced) X Quantity (number of goods and/or services sold.)

This is a fact and nothing can change it.

Now here’s the problem — we state “PQ” (otherwise known as GDP) in units of “M”.

If you don’t understand the problem that QE presents (indeed, that any borrowing presents) with this you’re not very bright.

Short-term borrowing — that is, a loan that is quickly extinguished — doesn’t change “M”.  It time shifts a transaction but economically is otherwise a non-event from a monetary perspective.  If I borrow $100 from you to buy a night at the bar, get paid on Friday and give you back your $100 (with or without interest) I have simply changed the night at the bar’s economic event from Friday to Tuesday; further, the event Tuesday now cannot happen on Friday (as well) because the $100 has already been spent.

I have not changed whether it happens at all.

QE, however, is a permanent change in “M”.  It is intended to “make up” for private borrowing for which there is either no demand or no supply.  That is, in the market today there is insufficient incentive for private capital to be loaned either because the interest rate that can be earned doing so is unattractive for the risk inherent in the loan or there is nobody willing and able to borrow at the offered rate.

But since “QE” is not “paid back” and withdrawn it permanently changes the amount of “M” in the system.  Since GDP is stated in “M” to get an accurate account of GDP you must subtract back off any permanent change in “M” from GDP.

QE, on a rolling 12 month basis, is about $1 trillion.  The US Economy is about $17 trillion.  Therefore you must subtract the amount of QE added back out, which is about 5.9% of the total economy!

In other words with the current GDP “growth” of effectively zero (0.1%) the economy is in fact in deep recession as the actual “growth rate” is currently -5.8%.

This is caused by QE.