QE: Because Nobody’s Got Any Better Ideas

QE: What you’d call a bit of a controversial policy. Asset prices have shot up recovering pre-crisis highs. Meanwhile the real economy – especially those bits that affect the poor and the young – remain deep in a pit of despair. I don’t agree with Frances Coppola on this, but she’s got some good posts accusing QE of making things worse , especially in the UK. (there’s also this excellent subsite for discussion on the topic). And of course we have the insistence – from thereasonable to the reliably demented that this is all a bubble and that the next hard landing will be worse.

But I come not to bury QE, but to praise it. Or at least point out that it’s probably better than doing nothing, and that “nothing” seems to be a pretty good description of the other politically-acceptable alternatives globally.

First, let’s deal with the “QE distorts prices and changes the behaviour of investors”. This is like complaining that “cars carry people to different places”. It’s not an objection, it’s a description of the WHOLE DAMN POINT of the exercise. A case in point: the recovery of the housing market has been driven byinvestor demand. And it’s the big institutions – the WSJ link points to 20,000 homes snapped up by Blackstone. This is what happens when the search for income, driven out of Treasuries by low yields turns into activity. This is FoBOR at work (Forced Buyers Of Risk to use Dan Davies‘ term)

High maintenance costs traditionally had kept investors out of managing hundreds of scattered-site rentals. But investors set about overcoming those hurdles two years ago because low interest rates engineered by the Federal Reserve generated “a tremendous appetite for yield,” said real-estate consultant John Burns, who advises investor firms. “It really sent capital chasing to figure out this business.”

And Bloomberg on the same story

The firm, along with Thomas Barrack’s Colony Capital LLC and Two Harbors Investment Corp. (SBY), is seeking to transform a market dominated by small investors into a new institutional asset class that JPMorgan Chase & Co. (JPM) estimates could be worth as much as $1.5 trillion.

This is QE working as planned. Reduce the returns on assets like bonds to the point where other activities become interesting to investors. The payoff for the real economy is the considerable money investing in renovating the properties and mobilising the building sector (US homebuilding is the global economy’s Great Hope) by resuscitating demand.

Now, this is definitely a pretty roundabout way of driving money into the real economy. Instead of putting the money directly to work, pay money to people who already have assets even more than their assets are currently trading for, in the hope that they’ll put at least some of the money to work. It’s unkind but not entirely unfair to compare it to trying to persuade a fat man to take some exercise by massively overpaying him for his car. It can work. But it might also put him in the market to pay huge sums for any old piece of crap car in the hope that you’ll overpay for that one too.

Money has to be not just provided by the central bank, it has to be spent. The money can be spent directly by government (Keynesian style); plan B is Chinese-style directed lending. This isn’t the place to rehearse the debates about this, though I personally am very very suspicious of plan B. A “banking system responsive to local needs” quickly becomes “a piggy bank for local politicians” (see Spanish cajas). Everybody has their own view on this – but I’ll confine myself to the deliberately narrow “If Plans A and B are off the table, does QE do more good than harm?”

(Side note: QE is not Plan C “helicopter money” – which in practice might consist of crediting all bank accounts in the country. QE involves paying over a $ (or £, or Yen) amount in return for an existing asset. This is a crucial feature, and accounts for many of the drawbacks – in particular that the policy benefits above all existing holders of assets. In theory, just handing money to everybody in the country is a more effective and equal way of acheiving its aims. But you don’t have to be a hard-money Bundesbanker to be at least a little uncomfortable with where this might end up).

Politics suddenly looks pretty primary here: fiscal stimulation and liquidating the banks are apparently off the table, to the symmetrical disgust of Keynesians and Austrians. It’s easy for those close to the financial system to lose sight of this, and fail to ask the big question of why. So mysteriously we’re left with the only stimulus route which as a design feature favours those who already own assets, and even more those who own those assets via leverage. But can we at least recognise that fiscal expansions, directed lending and money printing are revolutionary and experimental and have massive drawbacks of their own. The same goes for “letting the banks take the pain”, as Cypriots can testify.

There’s plenty to object to about QE. Can it cause bubbles? Yes (though I for one am pretty adamant it hasn’t so far). Does it disproportionately benefit the wealthy over those on fixed incomes? Yes. As long as the banks are dysfunctional and reluctant to lend without collateral, this effect will be reinforced. This may well be why the UK variant of QE has been so unsuccessful compared with the US variety.  But, absent a revolutionary political change, QE (and its lesser cousins, OMT and LTRO) are the only game in town. I’ll lament the political gridlock that has left a dysfunctional and (outside the US at least) partially zombified financial system in place. But given a choice between zombies with and without QE, I beleive evidence strongly supports the former.