Does it matter who controls the businesses of the country? Does it matter who regulates the businesses of the economy? Should these people be smart or dumb?
One cost of the meddling that the Fed and Treasury have done through the bailouts is that dumb people are left in place. People who mismanaged their firms still manage them, and regulators that misregulated are still in their jobs. Both are rescued by taxpayer largess, but it reveals another hidden cost of bailouts — they make us less competitive/effective as a nation, because we do not let firms fail, and we don’t fire regulators that were negligent, including the Fed.
The optimal outcome would be for bright managers to buy failed firms out of bankruptcy, and for failed regulators to be replaced with new ones that have a chance of doing things differently. Aside from that, if you never fire regulators for failure, you will never motivate them to do what is right.
And this is true of most meddling by the Fed or the Treasury, picking favorites, not letting bad firms or regulators fail. This extends to QE. If you need lower rates in order to survive, you probably don’t deserve to. All a lower rate structure does, if the government or Fed is forcing it, is encourage investment in lower yielding investments, because they can be financed cheaply for now. This is an aspect of the liquidity trap, and the Fed is deepening it with their policies.
Remember, there is no evidence that QE works. It has not helped Japan; it may have harmed Japan.
What I have found interesting over the last week are the number of discordant voices that are not in favor of QE or fiscal stimulus. Here are some examples:
- Consider what John Taylor and Richard Berner have to say in this article.
- Listen to what Trichet has to say about government debt. He says that the failure to cut debt has led to Japan’s malaise.
- David Goldman questions QE here, suggesting that the US will fare worse with that strategy than Japan.
- Or consider Raghuram Rajan, who in this article argues that low rates encourage speculation in risky assets, which may not result in growth in the long run, which is similar to the arguments of Fed dissenter Thomas Hoenig, who is also cited in the article, and me . The difference that I have with Hoenig is that the economy is not strong here, and he thinks things are pretty good. Hoenig thinks that low rates are hindering growth because banks sit back and make risk-free profits lending to the Treasury, and I agree with that. It would be more stimulative of private sector lending to raise Fed funds to 1.5%, because then banks could not make money in Treasuries without taking a lot of interest rate risk. They would have to go out and make real loans, or shrink their balance sheets. Either would be good.
- For an odd pro-QE view, Thomas Palley argues something complex, suggesting that Fed funds should be raised to promote saving and restrain speculation, while QE should be used to depress mortgage rates and state general obligation bonds. I disagree, because we have too many houses, and state governments are too large now, having grown fat on the rising revenues generated by the credit bubble. But do you see how when the QE genie is let out of the bottle, every special interest lines up to plead for the investment? Bad enough that we have fiscal policy playing favorites for indebted homeowners at the expense of renters and those who own free and clear, but to make it a permanent part of monetary policy is foolish; it just creates a glut of homes, with marginal borrowers.
But consider Japan, which has not given up on QE, not because it works, but because they can’t think of an alternative. It’s not as if there is a lot of demand for loans in Japan, but the Bank of Japan boosts a loan program anyway in the political season.
It makes me think that both Japan and the US have a comeuppance coming. One cannot borrow forever without a bad result occurring, whether that be default, inflation, or high taxes. But, in the short run, that game can go on with the politically connected disproportionately benefiting. Though not on QE, this article from the Washington Post highlights the huge increase in Federal spending, and mentions in passing the huge benefits to DC, Virginia, and Maryland. Yes, the benefits flow unequally, and it wasn’t as if the mid-Atlantic region was in bad shape. Those near the capital benefit overmuch, and the hinterlands pay.
I stand by my thesis, which I hope to flesh out for stimulus spending in coming days. QE does not benefit the US economy in the long run because it:
- Creates dependency on the Federal Reserve to continue the financing.
- Subsidizes governments and industries that need to shrink, and focus on core demand, not further expansion of mission.
- Drives up the costs of funding long-term liabilities
- Drives down the marginal efficiency of capital as the government and central bank does more of the investing, and invests in low ROE, or even negative ROE ventures.
- Only looks at the present, and at politics, leading to decisions that benefit those connected
- Tempts investors to take non-economic risks, where they will lose more than if they had stayed in cash.
- Makes average people less certain about the future, which makes them more conservative in spending.
- Undermines confidence in the fairness of government, and the value of a central bank.
- It helps leave foolish men in charge of governments and bureaucracies that should have failed.