Richard Koo On The Weakest Links In The Bernank's QEasy Logic
Richard Koo's just released note has the usual set of insightful observations into the fringe Keynesianism which we all suffer on a daily basis, where one false move will lead to a systemic collapse, and as usual deals exclusively with the aftermath (and concurrent-math) of the Fed's QE. First, he brings forward the "ketchup declaration" which is a sad harbinger of what may soon happen to the US. "The “ketchup declaration” was made about a decade ago in the context of
an argument between the Bank of Japan and a group of overseas economists
that included Paul Krugman and Ben Bernanke. The BOJ’s position was
that quantitative easing could have no impact as long as there was no
demand for loans among businesses and households." What has happened, is that the BOJ adopted precisely what Bernanke espoused in the beginning of the last decade... to an abysmal failure. But that won't stop the Chair from repeating Japan's faults here. The scarier thought is that it is precisely Bernanke who will next proceed to monetize all equity-related assets: ETFs, REITs, and everything else. Yet the most notable argument, and the one which even Bernanke does not get in his push for reflation whose only hope is to get consumers to purchase on credit instead of just cash, is what happens if the US consumer is consuming, but is content to do so without leveraging again. That is by far the weakest link in Bernanke's argument. A link which will be broken soon enough by his relentless exporting of inflation, until such a point is reached that the entire world takes America aside, and tells them to get rid of the Chaircreature, or else.
Overseas, it seems some distrust of the Bernanke Fed remains and the Chairman’s proposal that the Bank of Japan buy ketchup in an attempt to reverse deflation is often cited.
The “ketchup declaration” was made about a decade ago in the context of an argument between the Bank of Japan and a group of overseas economists that included Paul Krugman and Ben Bernanke. The BOJ’s position was that quantitative easing could have no impact as long as there was no demand for loans among businesses and households.
Meanwhile, Mr. Bernanke argued that the Japanese economy would improve if the BOJ would start buying up things—including ketchup.
The concern appears to be that Mr. Bernanke will ultimately have the Fed buy ketchup and every other available asset in an attempt to prove the validity of his argument, and that the dollar will ultimately be turned into confetti.
However, the Fed chairman has adopted a much more pragmatic stance over the last year, a stance encapsulated in his remark that monetary policy alone cannot solve all the problems facing the US economy and that now is not the time to discontinue fiscal stimulus.
If many large Treasury investors overseas also remember Mr. Bernanke’s ketchup declaration and see QE2 as an extension of that view, there is a real possibility that further easing under QE2 will prompt them to sell US Treasury securities, which in turn could send US interest rates in an unwanted direction.
Whether there were overseas investors who agreed with and acted on this line of reasoning is uncertain, nevertheless, the sudden and unusually steep rise in long-term US interest rates following the QE2 announcement suggests we should at least consider the possibility.
Far more important, is Koo's observation that Americans, even in the aftermath of the biggest (dud of) shopping seasons in recent years, refuse to relever:
The Beige Book also noted that US households and businesses continue to deleverage, creating a situation in which banks’ preferred customers are not interested in borrowing. This is also identical to the situation in Japan more than a decade ago.
Banks hurt by the crash in commercial real estate are naturally reluctant to lend more to the sector, but potential borrowers in other sectors are not interested in borrowing despite current low interest rates. This has arrested growth in banks’ loan books—including consumer loans.
The implication is that during the Christmas shopping season consumers paid for their purchases with cash instead of credit. This reflects changes in the US credit card market and also suggests that US households are beginning to emerge from their dependence on debt.
If US households were to begin consuming only what they can afford without relying on debt, it would represent a sea change and would also be a first step on the path to a sounder US economy.
However, in that case, GDP and demand for commercial real estate would be unlikely to grow substantially amid modest growth in employment and incomes. Continued private sector deleveraging also means the government will need to continue generating demand for some time.
And that is, as we all know, is precisely the silver bullet that will one day go straight through the heart of the Chairwolf:
The Fed’s zero-interest-rate policy and quantitative easing will have almost no effect as long as the private sector continues to deleverage and demand for loans remains weak. No matter how much the monetary authorities ease policy, money will not start flowing and the money supply will not increase without private-sector borrowers.
Simply said, Bernanke will keep pushing more and more money into the system until the consumer, left with no choice, is forced to take out a loan just to subsist. The problem is that by then, not only all of Africa, but Asia, and possibly Europe will be gripped in the same daily riotous revolutions that have already swept away Tunisia and Egypt virtually overnight.
When the dominoes start falling, they fall very fast.
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