Wednesday, March 11, 2009
rothbard on the utility of quantitative easing
Economist Murray Rothbard ("America‟s Great Depression", Ludwig von Mises Institute 2000) made extensive analysis of why the inflationary policies of the US Federal Reserve failed during the Great Depression. Those policies proved to be counterproductive:“American citizens lost confidence in the banks and demanded cash.. for their deposits.. while foreigners lost confidence in the dollar and demanded gold.. The more that.. the Fed tried to inflate, the more worried the.. public became about the dollar, the more gold flowed out of the banks, and the more deposits were redeemed for cash.. The Fed purchase of government securities was a purely artificial attempt to dope the inflation horse..”
this has to be a core concern of every briton at the moment, with the bank of england having entered the gilt market to monetize government debt. the grand experiment intends to goose economic activity at the expense of the real value of the already-slashed pound, with some sincerely icelandic tail risk.
in normal conditions, a devalued currency could be expected to assist exporters as well. as mentioned by the financial times, there is considerable doubt as to the efficacy of that pathway amid a global demand collapse. so the primary intention is to increase the currency in circulation in the hopes that more on hand will mean more spending and (critically) more borrowing.
this clearly did not work well in the 1930s to the extent it was undertaken as banks chose to hoard cash (much as today). of course, the united states also experienced a series of devastating bank runs which reinforced that tendency. today, with the FDIC, bank runs are a much smaller problem. aren't they?
the hard answer is that "it depends". much of the catastrophe of 2008 can be seen as a run on the shadow banking system -- that is, the uninsured and off-balance-sheet extensions of the financial system. the contraction of that massive credit generator is analogous in its effect to a systemic bank run that has resulted in failed "banks", boggling capital losses and widespread (and justifiable) paranoia.
that run has at times extended to more visible elements of the banking system, forcing insurance to be put into place on an ad hoc basis -- such as the commercial paper and money market fund backstops put in place following the collapse of lehman brothers, which were hoped to be able to forstall a systemic run on those markets which was actually underway.
beyond that there is the question of the fate of crossborder deposits -- international depositors in american banks have heretofore been well treated by the FDIC, but their accounts are not legally protected. these accounts are a massive part of the deposits in money-center banks such as C or JPM. crossborder runs have already become a reality in some parts of the world during this crisis.
and there is finally the question of the FDIC itself. michael panzner forecast in his sometimes-eerily-prescient "financial armageddon" (and has repeated elsewhere) that eventually deposit insurance (along with many overpromised government-backed obligations) will likely have to be diluted or perhaps even eliminated in the crisis now underway as the fiscal position of government may not allow it to backstop all failed banks as the debt unwind progresses and the losses being assumed by the government through the FDIC and other pathways become overwhelming. the mere anticipation of that development could reintroduce the bank run to american society after a long absence, which is probably why sheila bair recently approached congress for a $500bn line to the treasury, a move many see as preparatory of the resolution of a money-center bank. this comes on top of a draconian assessment levied across all banks, leaving many smaller community bankers incensed at what some term "confiscating the capital of the industry" on the part of the government in service of the majors.
and this is not to mention hoarding in anticipation of runs on other elements of the financial system -- most notably of late the insurance sector, which rolfe winkler delves into today.
beyond simply engendering some healthy skepticism of the value of government insurance in a real crisis, the two-pronged point here is
- that quantitative easing may not work to promote economic activity through increased lending in part because the value of assurances against losses are, even and perpahs particularly where comprehensive, questionable;
- that quantitative easing, or rather monetization, may be the only resort to which government could really appeal in the case of multiple large-scale bank resolutions.
it is impossible to know how this would work out in detail -- but should we witness a real spate of dollar weakness in forex markets as things go along, government may be faced with some very stark choices about what it can really afford to backstop.