A Benjamin Cole post
The tight-money crowd is dominant in central-bank staffs, and so firmly (and self-perpetuatingly?) ensconced in such independent government sinecures that they look likely to outlast all rivals. That tight-money enthusiasts preach an increasingly dubious religion or ideology—I have dubbed it Theomonetarism—is unimportant. They have allies in media and academia, curiously always on the right-wing side of things (with some exceptions, such as Ramesh Ponnuru at National Review, James Pethokoukis at AEI, and Scott Sumner, of the Mercatus Center at George Mason University).
The latest tight-money sermon comes from Daniel Thornton, an excellent writer and former veep at the St. Louis branch of the U.S. Federal Reserve, who damns the Fed for quantitative easing (QE) and low interest rates, in Requiem For QE, written for Cato Institute.
The Thornton Allegations
Thornton says not only did QE accomplish almost nothing in terms of stimulus, it resulted in “unintended consequences.” From Thornton, “[T]he intention of the (Fed’s) policy is to distort asset prices in an attempt to reduce long-term yields. But such actions produce unintended distortions: a strong and persistent rise in equity prices, a marked change in the behavior of commodity prices, a resurgence in house prices and residential construction beyond what is warranted by economic fundamentals, and excessive risk taking, even by those who are least well situated to take it. These are the unintended consequences of QE and the FOMC’s zero-interest-rate policy.”
Thornton also reiterates that the Fed was kicking Grandma; poor and elderly savers get hurt by low yields. And, of course, Thornton sermonizes that QE and low interest rates threaten injurious inflation down the road.
Where To Start
Like wrestling with a criminal octopus in Sodom and Gomorrah, it is difficult to know where to begin with Thornton. Wrong is everywhere. But let’s just hack away.
- Thornton avers QE and low interest rates cause “a strong and persistent rise in equity prices.” Given where stock prices were in 2009, one is tempted to answer, “And?”
But beyond that, Thornton overlooks what stocks did in the 1990s, long before QE and zero bound. Today’s stock market (which anyway has been flat for the last year, and not “persistently rising”) is far more sober than that of 1999, when the average Nasdaq p-e was at 100x earnings, and the S&P 500 at 44.2x earnings. The fed funds rate in August 1999 was 5.25%, and no QE. The p-e’s on Wall Street today are slightly above long-term averages (now about 20 times earnings), even while corporate profits are at all-time record highs, absolutely and relatively. (QE evidently only has bad unintended consequences; Thornton does not say that QE caused corporate profits to soar to the moon.)
- Thornton also complains that QE-zero bound causes a “marked change in the behavior of commodity prices.” Well, one has to smile at this one. There were no commodity boom-busts before QE? BTW, gold hit $887.50 an ounce in 1980, before hitting $273.00 in 2000. Oil has been everywhere and done everything since the 1970s. I think what Thornton wants more than anything is to say, “higher commodity prices signal too-easy money.” That has been the standard refrain from the Theomonetarists since the 1970s, when the U.S. had double-digit inflation and OPEC was jacking up oil prices. In ensuing decades, we had the Chinese industrialization and full-throttle demand for all industrial commodities, while the U.S. ethanol program boosted corn prices, a basic agriculture good (they feed corn to pigs and cows, btw). Global oil was controlled by uncertain thug states. The last three decades have been a great run for commodities, and for inflation-hysterics who could endlessly siren about commodities prices.
But since QE started in 2009, commodity prices have been zooming—downhill. Copper has been cut in half, and gold is way off. Oil is cut in half too, and still going down. Thornton is reduced to saying QE results in a “marked change” in commodities prices. Yes, a “marked” reduction, so far. Frankly, there are global markets for commodities, and global supply. The Fed went to QE and a nominally low federal funds rate, and commodities prices subsequently tanked. What is the connection?
- Thornton credits a “resurgence in house prices and residential construction beyond what is warranted by economic fundamentals” to QE and low interest rates.
Here Thornton seems unaware the basic facts. Housing starts are in the toilet.
Actually, based on demographics, the U.S. has been under-building housing for years. As for house prices, noose-tight city zoning regulations prevent much new housing stock, and that plays a key role in national housing costs. Does Thornton mean to say U.S. apartments rents are rising (as they are), as there is too much residential construction? How does that work? The unfortunate truth is that even a merely mediocre economy in much of the U.S. will result in higher housing costs. It is a gigantic structural impediment. The solution to rising housing costs is much more liberal city zoning, or even no zoning. Thornton’s solution, on contrast, is to suffocate the economy enough that we obtain house price stability, despite regional housing shortages. Good luck with that—it is called 2008.
- Then we have Thornton’s assertion the Fed has caused “excessive risk-taking.” This reprises the “Fed as Mommy” role. You see, in free markets investors and business managers go bananas when interest rates are low. The free-market system is an inherently unstable platform on straw-like stilts, one that collapses whenever investors and business managers are not kept in check by an ever-vigilant Fed. Anyway, American corporations are actually sitting on huge piles of cash and not taking risks. There is not enough demand to warrant expansionist behavior by those who produce goods and services.
- I could go on, but another oddity is Thornton’s contention the Fed is too long in hugging the zero-bound tree. Yet, most economists would say the Fed cannot control long-term rates—that is, institutional investors will lend on 10-year Treasuries and other sovereign debt based on their gimlet-eyed assessments of yields, present value and the long-run economic landscape, not Fed antics. Okay, so the 10-year Treasury rate today, set by institutional investors, is 2% and pennies. If I quizzed a college class, “If in Free-Market Utopia Nation the 10-year sovereign-bonds sell at 2.00%, then what would you say the overnight federal funds rate should be?” I would answer, “Really, really low, as low as a morsel of snow.” That may explain why I did not get into Harvard, but the real answer would seem to be “somewhere near zero.”
- “Income was redistributed away from people on fixed incomes and toward better-off investors, “ avers Thornton, a reprise of the “Fed is bashing Grandma” argument. One wonders how to respond at less than encyclopedic length to this assertion. Interest rates have been falling globally for decades, and are negative now in many nations, including the famously tight Switzerland. Low rates are a sign that money has been tight, as Milton Friedman said. Monetary policy must be made for the general good, not any particular group or region. Raising rates hurts investors of all stripes—including those who risk equity to start businesses or invest in real estate. In fact, the Fed must be callous about poor people invested only in short-term risk-free assets. Helping the poor is the job of government and charity, not central bankers.
- Thornton adds, the “huge increase in the monetary base that QE entailed could cause inflation if the Fed loses control of excess bank reserves.” Again, one must suppress a smile here. Since 1980, has the tight-money crowd ever written a monetary paper that did not warn of the perils of pending inflation, due to Fed laxity? We have lived through five of the last zero hyperinflations, about 23 runaway inflations, and 71 double-digit inflations. Oddly, after decades of wanton laxity by our central bank, we are now paying the price—core PCE inflation is drifting down towards 1%, or perhaps lower if the Fed induces another recession.
In many regards, I have not been fair to Thornton in this brief blog. Thornton does ponder why the Fed is paying interest on excess reserves, thus suffocating some of QE’s stimulus effect. Thornton also criticizes the Fed for not expanding its balance sheet pre-2008, in the early days of failures by financial institutions.
As I have said before, the tight-money crowd has been increasingly erratic since 2009, and the failure for inflation to erupt following QE, or for there to be any detectable consequences for the Fed’s balance sheet (other than taxpayer relief, and some stimulus), let alone catastrophic results. The Theomonetarists are reduced to flying their tattered, sun-bleached storm flags for inflation (as does Thornton), and attributing all present-day economic ills to QE or low interest rates.
In fact, the Fed is too tight. We see weak demand, but global supply lines are thick and unused. We see that PCE core inflation is sinking below even the Fed’s niggardly 2% target. We see unit labor costs nearly dead-flat for years on end, a rising dollar, up 20% in last 18 months.
The Fed should target a robust growth rate via nominal GDP level targeting, and heavily use all tools at its disposal to get there, including QE and even negative interest rates.