Friday, November 19, 2010

Quantitative easing explanation, further explained

One of my church elders  asked me if the QE video here is true. My explanation to him after the embed.

Yes it is 99% correct.

The Ben Bernank is probably the pre-eminent expert on the Great Depression. QE is not a good thing, but monetary shocks are worse, and the more money that leaks out for now the better. I am glad he is there, but his policy for the US today sort of contradicts his policy criticism of Japan a decade ago.

I am not sure I know anyone better than The Ben Bernank to chair the Fed, with the possible exceptions of Glenn Hubbard, Greg Mankiw, Lars Svensson, or John Taylor. Do you know somebody else more qualified--smart, not a priest of the Church of Unlimited Government, and even keeled in this area?

The Fed's dual mandate is price stability (2-3% inflation) and maximum employment (94-96%). The problem is that unemployment is still high, and the only real dial the Fed can turn is money supply and short term interest rates. If it contracts the money supply, standard theory says that unemployment will rise, but inflation will ease. The interesting thing is that there is record low inflation. I speculate it is because people are incentivized to not spend, so it doesn't matter how much money the govt prints, its not being spent. So inflation stays low, and unemployment stays high.

There are plenty of competitors to The Goldman Sachs, so even though there is some transaction cost and economic friction in transacting with the US Treasury, it's better than it has ever been in history.

If central banks, including the Fed, act irrationally, then smart investment banks and/or hedge funds will make a ton of money (like Soros did against the British pound).

If the Fed said that the world should spend $1,000 on every Bible, then The Goldman Sachs would borrow as many Bibles as people would lend them (say, for $50), sell them to government agencies and anyone else who would take them for $1,000, and then wait until Bibles fell back to proper valuations, say $30, buy them back and return them to their owners and make a bazillion dollars.  Future taxpayers get hosed.

Goldman is seeking and speaking the truth in this case, by forcing prices toward reality and away from foolish policy. They are rarely the false teachers speaking the words our itchy ears wish to hear (with some interesting exceptions).

So it turns out Lloyd Blankfein is doing God's work, at least more than irrational central banks.

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