A more malign interpretation of increased consumer spending
By Marshall Auerback
Yesterday, Ed wrote a good piece on consumer spending and the return of the economy to the status quo ante. I think it’s a little bit more malign than that.
There has been a real positive change in the underpinnings of this economic recovery and it all derives from the “consumer conundrum”. It strikes me that the US consumer has got some "savings fatigue" and the budget deficits had facilitated some deleveraging and build-up of savings, which clearly is being drawn down now to re-start this consumption. But this is still inherently private debt constrained, which is why it is not sustainable in my view without employment growth.
Also, bear in mind that consumer spending strength was all at the “high end”, as Ed has pointed out many times. I think this strong consumer performance was probably in part stock market related. And stock market strength was clearly QE2 related. However, the mechanism by which this happened is not at all clear. Remember, the Fed has argued that QE works through the ”portfolio balance channel” by lowering long-term interest rates and thereby lifting the stock market, housing activity, and corporate spending. However, in the fourth quarter the long-term rate of interest rose, and by a considerable amount. It was therefore not responsible for stock market strength. It was not responsible for housing sector strength, as all housing sector measures were flat to down. Home prices fell. It was not responsible for a corporate spending splurge; capital spending was up at only a 4% rate which is a low rate for this GDP component in an economic recovery. Also, corporate cash flow and cash balances have been so high that the long-term rate of interest probably now has little relationship to corporate spending. In other words there is no obvious traditional direct economic relationship between QE and the fourth quarter splurge in consumer spending and overall real final sales.
It is my position that the Fed is succeeding with QE largely through the psychological impact of its “rhetoric” or “expectations management” or whatever you want to call it. In other words, it is succeeding largely through the encouragement of belief on the part of market participants that it will move heaven and earth to get the stock market up. The Fed is pulling the economy up by its bootstraps by fostering mega moral hazard. Maybe employment and income will follow. But for now the improved economic recovery is based on Fed conjured psychological effects more than anything else. And that’s why I am a long term sceptic.
In QE2, 600 billion USD worth of bonds are replaced by 600billion USD worth of hard cash. This cash has to find some place to be parked. That place happens to be the stock market and commodities. This impact is real and not just psychological. That newly created cash could not percolate down to the main street is a different story and is outside the scope or capability of Fed Reserve.
The new cash had to be exchanged with someone else. Someone accepted the cash in exchange for securities. The only thing that happened is the buyer of the stocks and commodities were more willing to pay higher prices. The new cash is still new cash. It has not been parked anywhere. It is simply in the seller’s hands.
When the cb purchases tsys it takes risk-free items off the table, thereby increasing demand for increased risk, given that the funds are not going to be left sitting in deposit accounts and probably not consumed either. Moreover, with no bottom in on RE, funds are not flowing in that direction either. Since QE results in increased liquidity, increases in deposit accounts through QE simply be switched into higher risk financial assets instead of being consumed or invested. This drives up the price of risk assets.
In QE2, 600 billion USD worth of bonds are replaced by 600billion USD worth of hard cash. This cash has to find some place to be parked. That place happens to be the stock market and commodities. This impact is real and not just psychological. That newly created cash could not percolate down to the main street is a different story and is outside the scope or capability of Fed Reserve.
The new cash had to be exchanged with someone else. Someone accepted the cash in exchange for securities. The only thing that happened is the buyer of the stocks and commodities were more willing to pay higher prices. The new cash is still new cash. It has not been parked anywhere. It is simply in the seller’s hands.
When the cb purchases tsys it takes risk-free items off the table, thereby increasing demand for increased risk, given that the funds are not going to be left sitting in deposit accounts and probably not consumed either. Moreover, with no bottom in on RE, funds are not flowing in that direction either. Since QE results in increased liquidity, increases in deposit accounts through QE simply be switched into higher risk financial assets instead of being consumed or invested. This drives up the price of risk assets.
Hi Marshall,
The other half to the psychological effects from the Fed may simply be their influence on expectations about future prices of goods and services. While I largely agree with winterspeak’s recent posts on most of inflation expectations theory being bunk, there certainly are SOME discretionary purchases especially among wealthier demographics that may be triggered by expectations of rising prices.
A friend I saw in December made a comment along the lines of “but aren’t we entering an inflationary period?” I didn’t get a chance to ask him if his perception was based on Fed QE actions, commodity prices, the general ongoing recovery, or something else…
Of course the extent to which both psychological factors can kick start a higher level virtuous cycle of rising incomes and spending versus a more rapid fade out remains to be seen…
Hi Marshall,
The other half to the psychological effects from the Fed may simply be their influence on expectations about future prices of goods and services. While I largely agree with winterspeak’s recent posts on most of inflation expectations theory being bunk, there certainly are SOME discretionary purchases especially among wealthier demographics that may be triggered by expectations of rising prices.
A friend I saw in December made a comment along the lines of “but aren’t we entering an inflationary period?” I didn’t get a chance to ask him if his perception was based on Fed QE actions, commodity prices, the general ongoing recovery, or something else…
Of course the extent to which both psychological factors can kick start a higher level virtuous cycle of rising incomes and spending versus a more rapid fade out remains to be seen…
Our government and corporations tamped down real total compensation (TC) of millions of workers for 30 years, 1980-2010, especially with exporting capital and jobs to Asia. In China, TC is only 3% of what US workers make. We couldn’t do that and expect Americans not to get over-leveraged and end up in this credit crunch (greatly worsened of course, by the “Ownership Society” housing & MBS bubbles.) Look for example at the history of auto installment buying: from 100% cash at purchase to now loans stretch to 5-6 years. How much farther can that go?
Employment and mass consumption (MC) are a chicken and egg problem. Salary and wages are the main means of Americans to engage in mass consumption. You can’t get MC back without getting employment back and you can’t get employment back without getting MC back!
Worse: beyond the real job-killers (automation, merger, acquisition and downsizing, and capital export) BLS and Alan Blinder (Princeton) estimate 30 – 33 million more jobs can be offshored. The US needs industrial and incomes policies. Free trade as an industrial policy has “picked losers” among American industries which it has given to foreigners. A start at both policies would be to re-institute the TANF subsidized employment program at a factor of 10 over its original funding (only $5Billion.) Helpful too, would be a massive shared work program; incentives to retire early, hours limitations, partial retirement, mandatory vacations and leaves. Fix Social Security by increasing the contributions, not making geezers cling to jobs while youth can’t get any jobs.
I an beginning to think that the only solution will lie in credit controls so having a significant impact on those that offshore jobs. The problem is that at the moment QE is not staying in the US it is flooding into commodities because returns elsewhere are so pitiful. This is indirectly causing the downfall of regimes in the middle east. That could impact on the supply of oil and mean that the US economy slumps when oil rockets again. Oil is over $100 again and yet China is slowing down the US is still idling as is much of Europe.
In the interim the US needs a fiscal solution not a monetary one. Unless governments learn the limitations of monetary policy they will inevitably flood the markets with money. This will and has created destructive bubbles elsewhere.
Interesting comment. Can you point me by any links to how “credit controls” could be implemented in the U.S.? (I think maybe I have a deficit in interpreting English – English in American terms.) Also, given that money is fungible, what might be evidence that the QE money is going into commodities? My impression is that oil prices are jacked up far beyond cost of production on any excuse the world political situation gives to futures speculators on the ICE market by OPEC, the NOCS, and banksters, e.g., Goldman, Sachs, etc.
The fact that it is fungible does not mean that money is not flowing into commodities. There has been a significant inflow of funds into commodity funds especially in the US. The banks are not finding anyone willing to borrow at their new terms in the US so what are they doing with it all? They are not paying down debts or toxic securities. It has to go somewhere and the dollar carry trade has ballooned recently.
Tough capital controls might reduce world trade but by the same token it will greatly assist rebalancing the economy. Companies will need to locate jobs to cover domestic demand. It could have a positive impact on corporation taxes. It would be considerably harder to offshore profits and reduce tax liabilities. If it could not repatriate enough profits to pay dividends its share price could slump leaving it vulnerable to take over. The world did very nicely with capital controls, it did not suffer shocks too often and recessions were shallow.
Our government and corporations tamped down real total compensation (TC) of millions of workers for 30 years, 1980-2010, especially with exporting capital and jobs to Asia. In China, TC is only 3% of what US workers make. We couldn’t do that and expect Americans not to get over-leveraged and end up in this credit crunch (greatly worsened of course, by the “Ownership Society” housing & MBS bubbles.) Look for example at the history of auto installment buying: from 100% cash at purchase to now loans stretch to 5-6 years. How much farther can that go?
Employment and mass consumption (MC) are a chicken and egg problem. Salary and wages are the main means of Americans to engage in mass consumption. You can’t get MC back without getting employment back and you can’t get employment back without getting MC back!
Worse: beyond the real job-killers (automation, merger, acquisition and downsizing, and capital export) BLS and Alan Blinder (Princeton) estimate 30 – 33 million more jobs can be offshored. The US needs industrial and incomes policies. Free trade as an industrial policy has “picked losers” among American industries which it has given to foreigners. A start at both policies would be to re-institute the TANF subsidized employment program at a factor of 10 over its original funding (only $5Billion.) Helpful too, would be a massive shared work program; incentives to retire early, hours limitations, partial retirement, mandatory vacations and leaves. Fix Social Security by increasing the contributions, not making geezers cling to jobs while youth can’t get any jobs.
I an beginning to think that the only solution will lie in credit controls so having a significant impact on those that offshore jobs. The problem is that at the moment QE is not staying in the US it is flooding into commodities because returns elsewhere are so pitiful. This is indirectly causing the downfall of regimes in the middle east. That could impact on the supply of oil and mean that the US economy slumps when oil rockets again. Oil is over $100 again and yet China is slowing down the US is still idling as is much of Europe.
In the interim the US needs a fiscal solution not a monetary one. Unless governments learn the limitations of monetary policy they will inevitably flood the markets with money. This will and has created destructive bubbles elsewhere.
Interesting comment. Can you point me by any links to how “credit controls” could be implemented in the U.S.? (I think maybe I have a deficit in interpreting English – English in American terms.) Also, given that money is fungible, what might be evidence that the QE money is going into commodities? My impression is that oil prices are jacked up far beyond cost of production on any excuse the world political situation gives to futures speculators on the ICE market by OPEC, the NOCS, and banksters, e.g., Goldman, Sachs, etc.
The fact that it is fungible does not mean that money is not flowing into commodities. There has been a significant inflow of funds into commodity funds especially in the US. The banks are not finding anyone willing to borrow at their new terms in the US so what are they doing with it all? They are not paying down debts or toxic securities. It has to go somewhere and the dollar carry trade has ballooned recently.
Tough capital controls might reduce world trade but by the same token it will greatly assist rebalancing the economy. Companies will need to locate jobs to cover domestic demand. It could have a positive impact on corporation taxes. It would be considerably harder to offshore profits and reduce tax liabilities. If it could not repatriate enough profits to pay dividends its share price could slump leaving it vulnerable to take over. The world did very nicely with capital controls, it did not suffer shocks too often and recessions were shallow.