Quantitative Easing and the Importance of Job Growth

As the US stock market gyrates, Ben Bernanke’s pet project, Quantitative Easing (QE), remains the topic of the day. Most of the creditors to the US scorn QE as a reckless dalliance with currency debasement. On the other side, most of the debtors in the US applaud QE as a miracle elixir that’s “good for what ails thee.”

Both sides have a point. When you debase a currency, creditors lose and debtors win. And last we checked, the US government owed a lot of money to a lot of people. Lucky for it, minting a dollar bill requires only about two cents worth of paper and ink. So a little bit of extracurricular money-printing really lightens the debt load.

Obviously, to the extent that creditors are amenable, printing the money with which to repay them is a terrific idea. The problem is; creditors don’t usually tolerate such shenanigans for very long.

Chairman Bernanke insists that his QE project has nothing to do with subtly defrauding creditors. He says he is merely pursuing the Fed’s dual mandate: stable inflation and maximum employment. But QE seems to be all about maximum inflation in the pursuit of stable unemployment. At a minimum, QE reduces the Fed’s dual mandate to a solo mandate: job growth. Chairman Bernanke admits as much.

In a speech last week Bernanke remarked, “On its current economic trajectory the United State’s runs the risk of seeing millions of workers unemployed or underemployed for years… As a society, we should find that outcome unacceptable.”

Bernanke is clearly favoring the employment mandate over the “stable inflation” one. As such, he insists his QE tactics can grease the gears of economic rejuvenation. Unfortunately, the evidence-to-date contradicts this assertion.

“Since November 25, 2008, when the Fed announced that it would begin purchasing debt and mortgage-backed securities by Fannie and Freddie,” observes Evan Lorenz of Grant’s Interest Rate Observer, “the rate for new, conforming 30-year mortgages has declined by 1.6 percentage points to 4.32%, according to Bankrate.com. Yet, new-home sales have fallen. They dropped 26%…[since] the start of the mortgage buying.

“Over the same span,” Lorenz continues, “sales of previously lived-in, or ‘existing,’ homes fell 9%…One might argue that the Fed, its pure motives notwithstanding, is making things worse by preventing the market from clearing.”

But the housing market is not the only portion of the economy that would provide damning evidence against quantitative easing. Even after two years of mega-billion-dollar meddling by the Federal Reserve, signs of economic recovery remain scant.

“The New York Fed’s Empire Index of manufacturing activity took a dive in the current reporting month,” observes David Rosenberg, The Daily Reckoning’s favorite economist, “swinging from +15.73 in October to -11.14 in November, the largest swing ever recorded in a single month and the worst showing since the depths of the recession in April 2009.”

Numbers like these are indisputably bad, but maybe they would have been worse if Bernanke hadn’t intervened. Maybe Ben’s intervention in the private sector prevented the arrival of the Great Depression II.

Maybe…but probably not.

“Some intriguing research in the contrary vein is worth considering,” writes James Grant, taking the baton from his colleague. “‘A Decade Lost and Found: Mexico and Chile in the 1980s,’ by Raphael Bergoeing, Patrick J. Kehoe et al., published in 2002, might serve as a parable for these interventionist times. The paper contrasts the response of Mexico and Chile to the seemingly intractable difficulties each faced in the 1980s.

“Despite a similar starting point, the authors write, ‘Chile returned to trend in about a decade and since then has grown even faster than trend. In contrast, output in Mexico has never fully recovered, and even two decades later is still 30% below trend.’

“The difference? Chile let companies fail and markets clear. Mexico, anticipating certain features of the contemporary United States, allowed its archaic bankruptcy system to perpetuate the lives of money-losing businesses and allocated credit by government directive.

“The sharp recession that Chile suffered in consequence of its seemingly harsh policies,” Grant continues, “merely proved the preface to a superb recovery. In comparative terms, Mexico stagnated. Washington, DC, please copy.”

Here’s an idea: offer Ben Bernanke a generous retirement package, dismantle the Fed, re-establish the dollar’s link to gold…and let the market’s sort it out.

Eric Fry
for The Daily Reckoning