Bill Gross on quantitative easing, economic stimulus and recovery
Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co., recently wrote that he now takes a less optimistic view of what he dubs "Keynesian consumption remedies." As a result, he talks to Bloomberg about the possible need for more, non-fiscal, economic stimulus in the wake of James Bullard’s call for more quantitative easing.
Two things:
- QE is just a shuffling of net financial assets. It’s basically an asset swap since T-bills yield next to nothing. Get ready for another pile up of excess reserves.
- QE could work well in inflating asset prices more than consumer prices – but that could serve the Fed’s purpose too.
I have always viewed QE with scepticism. It wasn’t effective the first go round exceptregarding asset prices. And I don’t see QE preventing a slowdown in growth in the US this time either. That means yields will remain low. Gross’s Total Return fund has been doing quite well as yields have come down. See Bloomberg’s post "Pimco’s Bill Gross Rolls Down Treasury Yield Curve for Non-Normal Returns."
Gross also has some interesting comments about the asset-based economic model and whether the US can get out of debt with more debt late in the video. This is a theme he took up in his monthly commentary earlier in the year. See my posts "Can you get out of a debt crisis by piling on another layer of debt?" and "Gross: Is it possible to get out of a debt crisis by increasing debt?" for more on this.
Ed-
If we get QE2, do you still see markets rallying, or going lower, as the business outlook continues to worsen? Perhaps, first a rally, then back to a decline?
It all depends on the economy really. I don’t see markets rallying a lot in the face of the earnings disappointments I expect to materialize later this year and in 2011. Unless job growth improves, this is what is likely.
I agree with you that QE didn’t have much effect on the economy the first go around, but the Fed members seem rather convinced of it power to stimulate the economy. My question is why? It seems to me that other than its effect on asset prices, QE works only to the extent that it induces more credit creation. Do you see other ways for the QE to stimulate the economy other than through more credit? I guess my bigger question for the Fed would be, given the extraordinary amount of debt in the system, why would they want to there to be more credit created.
You don’t need to stimulate the economy through more credit. That’s the
primary misunderstanding under which the Fed operates. Credit follows
creditworthiness. You have a problem of aggregate demand. As I’ve said before,
the 1930s represented a classic illustration where industrial activity and
economic growth significantly preceded any increase in credit. The
financial dynamics of that huge economic recovery between 1933 and 1937 are
extremely striking. Despite their insistence that changes in the stock of money
were behind all the cyclical ups and downs in U.S. economic history, even
Freidman and Schwartz in their “Monetary History of the United States”
*conceded that the money aggregates did not lead the U.S. economy out of the
depression in 1932-1933.* *More striking, private credit seemingly had nothing
to do with the take off of that economy. Industrial production off the
1932 low doubled by 1935*. *By contrast, bank credit to the private sector
fell until the middle of 1935.* Because of the collapse in nominal income
during the depression, the U.S. private sector was more indebted than ever on
the depression lows. Yet, somehow it took off and sustained its takeoff with
no growth in private credit whatsoever. The 14% average annual increase in
nominal GDP from early 1932 to 1935 resulted in huge private deleveraging
because nominal income outran lagging private consumption.
.
In a message dated 8/2/2010 12:49:12 Mountain Daylight Time,
writes:
I don’t disagree with you, but my question wasn’t whether we need monetary stimulus.
I am trying to understand the Fed’s thinking. They clearly think QE/monetary stimulus has a stimulative effect on the economy, and that more QE would provide more stimulus. I would argue that it usually would, but the question is how. I seems to me that monetary stimulus stimulates the economy by lowering interest rates thereby inducing more credit creation. So my first question is whether there are any other ways monetary stimulus works other than through more credit creation (other than a benefit to asset prices).
I asked the question this way because unless there is some other benefit to the economy from monetary stimulus other than through more credit creation, then the Fed must want more credit creation. Given the amount of debt in the system, this strikes me as insanity.
Well, you would argue incorrectly. QE never has any impact on credit
creation because banks don’t lend out reserves.
It is based on the erroneous belief that the banks need reserves before
they can lend and that quantitative easing provides those reserves. That is a
major misrepresentation of the way the banking system actually operates.
Bernanke himself contributes to this misperception. About this time last
year, Bernanke addressed the London School of Economics, and spoke of the
inflation risk that some see as being integral to the expansion of the central
bank’s balance sheet. He said:
Some observers have expressed the concern that, by expanding its balance
sheet, the Federal Reserve is effectively printing money, an action that
will ultimately be inflationary. The Fed’s lending activities have indeed
resulted in a large increase in the excess reserves held by banks. Bank
reserves, together with currency, make up the narrowest definition of money, the
monetary base; as you would expect, this measure of money has risen
significantly as the Fed’s balance sheet has expanded. However, banks are choosing
to leave the great bulk of their excess reserves idle, in most cases on
deposit with the Fed. Consequently, the rates of growth of broader monetary
aggregates, such as M1 and M2, have been much lower than that of the monetary
base. At this point, with global economic activity weak and commodity
prices at low levels, we see little risk of inflation in the near term; indeed,
we expect inflation to continue to moderate.
Strictly speaking, Bernanke is not really making the point that the
expansion of reserves increases the capacity of the commercial banks to make
loans. Rather, he suggests that banks now have huge reserves but they are “
choosing to leave the great bulk of their excess reserves idle”.
This is incorrect. Banks DO NOT use reserve balances to create loans.
They create loans and deposits simultaneously out of thin air. They use
reserve balances to settle payments or meet reserve requirements ONLY. If a bank
is short reserve balances for either of these purposes, the Fed provides
an overdraft AUTOMATICALLY at a stated penalty rate, which the bank then
clears via the money markets or the cheapest alternative. Whether banks in the
aggregate hold $1 or $1 trillion in reserve balances, there operational
ability to create loans is the same: it is infinite (Though the creation of
even 1 loan requires a willing, creditworthy borrow in the first place, of
course.) Thus, neither the Fed, nor any other central bank actually provides
reserve balances that banks can “lend or use” to purchase assets, but
instead setting a cap on the cost of bank liabilities at different maturities
when they do make loans or purchase assets.
That is how loan creation works in post-gold standard world, in economies
where there are freely floating non-convertible exchange rates. The belief
that banks need reserve balances in order to lend is only applicable in a
gold standard-type of monetary system. The correct conclusion is that the
banks are fully capable of “getting money to struggling businesses” but
are unwilling to do so under present circumstances because (a) aggregate
demand is so weak that they cannot find credit-worthy customers worthy of
extending loans to (relating to his earlier point); and (b) the budget deficit is
currently not sufficient to engender any confidence among borrowers that
the things they might produce by expanding production (with working capital
borrowed from the banks) will be sold. Improving “creditworthiness” and
credit will follow. Bernanke, King and virtually all central bank governors
seem to proceed from this conceptual confusion.
In a message dated 8/2/2010 14:18:53 Mountain Daylight Time,
writes:
I am trying to understand the Fed’s thinking. They clearly think
QE/monetary stimulus has a stimulative effect on the economy, and that more QE
would provide more stimulus. I would argue that it usually would, but the
question is how. I seems to me that monetary stimulus stimulates the economy
by lowering interest rates thereby inducing more credit creation. So my
first question is whether there are any other ways monetary stimulus works
other than through more credit creation (other than a benefit to asset
prices).
I wanted to respond back to Marshall’s last post in this thread but couldn’t figure out how to do so.
Marshall, I never suggested that banks needed reserves to make loans. In fact, I agree with you that the loans come first, and the banks then go looking for the reserves to the extent that they need them. I think that in general, monetary stimulus leads to lower interest rates which in turn makes borrowers want to borrow more (everything else equal) and may make banks want to lend more. So, in my view, it’s lower interest rates that generally leads to credit creation, not excess reserves. Today, everything else isn’t equal and I suspect that private sector balance sheets and lack of confidence will restrain credit growth regardless of what the Fed does with interest rates.
All that though isn’t really important to my question which is what is the Fed thinking. Do they really want more lending? I don’t really think more QE will lead to more credit creation, but if it did, that would be a terrrible outcome as there is too much debt in the system now.
Zimmer, here’s what I think Fed officials (and many economists) believe. They believe that the US is in a weak recovery which could peter out and turn into a nasty double dip. The question – especially given the opposition to fiscal stimulus – is what can the Fed do.From a conventional perspective, the Fed would like to lower short-term interest rates. But since they are zero, they can’t. If they try anything now, they will be forced to take unconventional measures. The most requested is QE which adds high powered money to the banking system. The thinking is that this money increases the pool of loanable funds and therefore increases lending. The problem with this thinking is that all available evidence suggests that credit demand drives increases in reserves not vice versa. So Marshall is telling you that pumping reserves into the system isn’t going to do anything except swap one zero yielding asset for another. This is where we we all agree. The reserves just pile up as they did the first time around. The fed WANTS to increase lending but they CANT.Now, given the fact that people are over-indebted, you should be sceptical about this desire to increase lending to begin with. Clearly, the Fed is looking to limit the deleveraging process and their policies are designed to reduce savings and increase lending. But, as you say, debt stress is such that this credit creation is going to be hard to come by unless you get a sustained increased in asset prices against which to borrow.I think the Fed can manufacture some asset price appreciation by forcing people into risky assets as it trashes cash. This will induce some additional credit demand at the margin. But households are now so indebted that any hiccups in asset prices or the economy are going to crater loan demand.
I believe Marshall Auerback has nailed it, although if you take it one step further you have to ask why Bennie and the Treasury are heaping such large sums of money on banks which don’t lend (and they know it’s a bad lending environment, but they’re giving them the money anyway). I can think of one very good reason, to keep those specific banks in business even though rumor has it they’re mostly insolvent (several times over perhaps). The US Government relies on those large banks, primary dealers, in order to fund itself. If those TBTF banks suddenly disappeared, not only would the US Government be forced into drastic austerity cuts in workforce and outlays, but maintaining global dollar hegemony would be very difficult as well. Imagine the embarrassment if the sponsors of the almighty dollar and policemen to the world, could not even keep bank employees around to facilitate the currency movements… it would be an invitation to all kinds of nefarious activities (outside the US Government that is).