The age of deleveraging

Source: Investors Insight

Before we get into this week’s outstanding Outside the Box, I want to comment on QE2 and the efforts by some Republican economists to urge legislators to get involved to stop it (see the front page of Monday’s Wall Street Journal). That pushes my comfort zone a little too much.

First, I am not a fan of QE2. Never have been. If it had been my call, I would have punted and told the guys in the Capital that the ball was in their court to get their fiscal house in order, because that is the main source of the problem. But Bernanke and the Fed felt they had to “do something,” to demonstrate they got the seriousness of the situation. If the only policy tool you have left is the hammer of printing money, then the world looks like a nail.

Second, I doubt it works. It might be interesting to see what would happen (theoretically) if they decided to print $3-4 trillion. Now that would have a (probably very negative) impact. But it would show up on the radar screen. I think $600 billion just gets soaked up in bank balance sheets, sloughed off to world emerging markets (that don’t want it) and other hot spots, with some drifting into the stock market. But does it increase real final demand, which is what the Keynesians are so seemingly desperate for? I doubt it. And I just don’t see the transmission mechanism for QE2 to produce new employment of any statistical significance.

Third, targeting the middle of the yield curve is about as benign a way as you can do it, as far as QE goes. It certainly is not bringing down mortgage rates (so far). This is not exactly shock and awe QE.

Now, if the real plan, which no one can mention in polite circles at G-20 meetings, is to weaken the dollar, then QE2 just might work at doing that. But do we want it to? Do we want our input prices to go higher? A weaker dollar cuts both ways. And Germany seems to be able to work with either a strong or a weak euro. Are they that much better than us? Really? I sincerely hope we can take Bernanke at his word that this policy is not meant to weaken the dollar. Currency manipulation is not what we need from the world’s reserve currency, nor will we hold that status much longer if we embark down that path.

Back to the Republican sortie against QE2. As long as it stays on a debate level, or even as a resolution, then fine. There is considerable room for debate, and some very serious economists on both sides of the issue. This is new territory and deserves to be debated vigorously. This is, after all, affecting the public. Fed policy is too important to be talked about only inside a conference room with a few appointed governors and economists.

But I do not want to see anything that would reduce the independence of the Fed from the political process (any more than it already has been reduced). I don’t want Republicans dictating Fed policy. Or Democrats. Or the President, beyond his power to appoint. That is the path to becoming a banana republic.

If We the People want to change Fed policy, then we need to realize it is important who we elect as president, because he appoints the chairman and the governors. Ideas matter and have consequences. How many times do presidential candidates get asked about their views on monetary policy in national debates? Are you a proponent of Keynes? Or Friedman? Fisher? von Mises? Which of these four dead white guys have you read and studied? These elections of ours are more than taxes and health care. The Senators who sit on the committees have the right to review appointees, though few understand the real issues regarding the Fed, I am afraid. (Wouldn’t it be fun to have Rand Paul on that committee? He could tag team with his dad in the House. Just a thought.)

Final thought. Maybe the reason for a less than shock and awe QE is that the Fed can get to the end of it and say, “Look, we tried. But the money just went back onto our balance sheet. Printing more doesn’t seem to be advisable.” (Especially if the public pushback gives them some cover.) Then they can back off and let Congress know that they have no intention of monetizing their fiscal profligacy and that Congress must get its house in order before the bond markets react negatively.

And then again I may be wrong. Maybe QE2 does do something. No one really knows because this is truly uncharted territory. We’ll find out in the coming months. And this Friday, in my weekly letter, we’ll look at the prospects for the economy going forward. I get back home tonight and will be home for two weeks. I am looking forward to catching up on my reading.

Now, for this week’s OTB I offer a review of Gary Shilling’s brand new book, The Age of Deleveraging: Investment strategies for a decade of slow growth and deflation.

Gary has long been a proponent of the idea that we are in for a period of deflation, and was writing as far back as the ’90s about the coming deflation. I am already into the book and am enjoying his wonderful prose, but must admit I skipped ahead to see his predictions, some of which are in the review below. You can buy the book at http://www.amazon.com/deleveraging.

URL to original article: http://www.housingwire.com/2010/11/16/the-age-of-deleveraging