QE2

by John Quiggin on November 4, 2010

The US Federal Reserve has announced its long-awaited renewal of quantitative easing (cutely labelled QE2). It’s $600 billion of new money to buy US Treasury notes with an average duration of five years, along with recycling of some money from the mortgage bailouts, also into T-note purchases. That sounds like a lot, but the reaction from Brad DeLong (endorsed by Paul Krugman) has been a big yawn. With the five-year bond rate at just over 1 per cent, the amount the private sector would demand to hold these bonds (that is, the annual interest payment) is about $7 billion, which is rounding error in the context of the current crisis.

I had been thinking that the Fed might take the much riskier (and politically trickier) step of buying corporate bonds. That would seem more likely to promote investment, but would obviously involve a good deal of winner-picking, with the associated potential for (real or perceived) corruption.

But what is really needed here is fiscal stimulus focused on job creation, combined with a long-term plan for fiscal consolidation (that is, higher taxes and/or lower expenditure). Instead, what the US appears likely to get is a permanent tax cut for the rich, partly offset by lots of job-destroying nickel-and-dime cuts in current expenditure. Many of these cuts will prove to be counterproductive or unsustainable in the long run.

{ 49 comments }

1

Tao Jonesing 11.04.10 at 4:35 am

Regardless of what Section 2a (added in 1978) of the Federal Reserve Act says, the Fed exists first and foremost to serve the banks. As a result, QE2 was not designed to create jobs but to provide the banks the seed capital necessary to loan themselves money (nobody else is borrowing, and they have a lot of debt to rollover) to use for speculation in commodities that are consumer staples. The increased prices that this will cause will create the illusion of inflation, but it will lead to a version of stagflation that will shift aggregate demand from discretionary spending to the bare necessities, which will increase unemployment (which you view as a bug but the banks view as a feature). A banker buddy of mine at Credit Suisse calls this “screwflation” (not approvingly, by the way). So, don’t pay attention to the smoke and mirrors, deflation is what is in store.

Your assessment that the tax cuts will prove “counterproductive and unsustainable” assumes that the goal is to reach full employment. But that’s not the goal. No, the goal is to recreate 70s style stagflation, which prompted dropping Keynesianism in favor of neoliberal Chicago School monetarism, so as to prompt dropping neoliberal Chicago School monetarism in favor of neoliberal Austrian School rentieronomics that lock in the ill-gotten gains that the Chicago School’s ponzinomics netted the rentiers. When you follow Hayek’s advice, all roads lead to serfdom.

2

billikin 11.04.10 at 5:15 am

“I had been thinking that the Fed might take the much riskier (and politically trickier) step of buying corporate bonds.”

What about buying state and municipal bonds?

3

Charles St. Pierre 11.04.10 at 5:23 am

Infrastructure projects, etc. Eh?

4

David Wright 11.04.10 at 7:03 am

Actually I’m kind of hoping that negotiations on the tax bill will reach a stalemate, so that all the Bush tax cuts will simply expire, for the rich, poor, and middle class. Not only will that help the government’s fiscal situation, but it would give the Republicans a great stick with which to beat Obama over the head in 2012. A fiscal stimulus would just move consumption from the future to the present; I’d prefer to have supressed standards of living now, under a Democratic administration.

5

Jack Strocchi 11.04.10 at 7:12 am

Pr Q said:

With the five-year bond rate at just over 1 per cent, the amount the private sector would demand to hold these bonds (that is, the annual interest payment) is about $7 billion, which is rounding error in the context of the current crisis.

Its interesting to watch federal agencies feverishly run through the various contingency plans for economic salvation, like a test pilot trying to pull an experimental plane out of a slow-motion spin. (Or maybe ER staff trying to revive a flat-lining patient, laid out on the guerney.)

Plan A: slash the interest rates to zero – check. (pushing on a string.)
Plan B: bail-out bankrupt banks – check. (paid for itself, but banks still recalcitrant)
Plan C: massive fiscal stimulus – check. (too little, too late)
Plan D: quantiative easing Mks I, II, III… – check (p*ssing in the wind)
Plan E: ??? (There appears to be no plan E.)

Yeah, the manual ends abruptly at Plan D.

Meanwhile the US jumbo continues its relentless descent towards the deck, with options running from soft-landing to crash-and-burn.

6

wolfgang 11.04.10 at 7:30 am

i think this all makes sense.
the treasury issues bonds, the Fed buys them, in between primary dealers trade them to make sure they get their annual bonus.
the system works.

7

Jack Strocchi 11.04.10 at 7:36 am

Pr Q said:

But what is really needed here is fiscal stimulus focused on job creation, combined with a long-term plan for fiscal consolidation (that is, higher taxes and/or lower expenditure).

You forgot to mention a pony for Christmas.

Pr Q said:


Instead, what the US appears likely to get is a permanent tax cut for the rich, partly offset by lots of job-destroying nickel-and-dime cuts in current expenditure. Many of these cuts will prove to be counterproductive or unsustainable in the long run.

Shorter Quiggin: There is no way the current legislative REPs are going to sign off on a large fiscal stimulus. So we’ll all be ruined.

Jesus, its a pity your wet blanket couldnt be used to stop global warming. Its certainly big enough.

8

Tom M 11.04.10 at 10:41 am

Um, Jack, your Plan B: bail-out bankrupt banks – check. (paid for itself, but banks still recalcitrant)?
I’m not sure recalcitrance is quite what’s going on. The regulators. having been asleep at the switch for quite a few years, are wide awake and pressing the buttons they forgot existed. Bankers make Type 1 errors where they make loans they shouldn’t and during the bubble period bankers were avid fans of this because it put a lot of money in their pockets. The regulators, often those who graduated in the bottom 25% of their class, let them.
Bankers also can make Type 2 errors where they don’t make loans they should make. In the present environment, the regulators are enforcing credit standards they left on the nightstand for the duration of the bubble and attempting to drive the Type 1 errors to zero but that makes the Type 2 errors increase substantially.
The pendulum swing like a pendulum do.

9

ajay 11.04.10 at 10:43 am

Meanwhile the US jumbo continues its relentless descent towards the deck, with options running from soft-landing to crash-and-burn.

Economy’s been growing for the last five quarters, private sector employment’s been rising for the last nine months.

Now, better policies could have made this happen better and faster and more, but it’s still not crash-and-burn.

10

Anderson 11.04.10 at 11:39 am

So, if the economy hasn’t recovered by 2012, that favors the GOP. They have no interest in economic recovery.

On those premises, what does Obama do? Agree to absurd tax cuts, etc. so that the GOP can’t say he failed to join their economic program and thus stalled recovery? But then what is the point of being president — keeping wingnuts off the Supreme Court? Helluva job, that.

Or is the economy likely to rebound by 2012 just in the course of things? In which case, will the GOP and the Fed actually sabotage it to make it worse and the GOP’s prospects better? (I am more than half convinced that Bernanke and some others on the Fed are partisans.)

11

Brett Bellmore 11.04.10 at 11:45 am

“Economy’s been growing for the last five quarters, private sector employment’s been rising for the last nine months.”

Debt has been increasing at unsustainable rates, is already at the point where, should T bond interest rates return to historically plausible levels the entire budget would be consumed by debt servicing. If you need to maintain an unsustainable policy to keep the economy looking vaguely ok, you ARE in trouble, even if you can put the final reckoning off for a few years at the cost of making it much worse.

It’s kind of like the difference between being normally wide awake, and swallowing another upper towards the end of a binge. If you squint they might look the same, but they aren’t, really.

Essentially the argument right now is whether to crash now, which would be bad, or crash later, which would be worse. But a crash is now inevitable, for all that “After me the deluge” is a more popular policy among politicians than, “Put on your hip waders, we’re having the flood next Tuesday.”

12

ajay 11.04.10 at 11:50 am

It’s kind of like the difference between being normally wide awake, and swallowing another upper towards the end of a binge.

Brett, you really have to stop thinking of economics in terms of substance abuse. If it’s not drink, it’s benzedrine. It’s a really misleading habit.

Debt has been increasing at unsustainable rates, is already at the point where, should T bond interest rates return to historically plausible levels the entire budget would be consumed by debt servicing

That’s not how T-bills work.

13

y81 11.04.10 at 12:38 pm

I don’t follow DeLong or Quiggin. Corporate bonds, commercial loans, home mortgages, etc., all price off the T-bond rate, so driving that rate down drives all the other rates down too. The $7 billion number doesn’t seem like the right measure.

14

Jack Strocchi 11.04.10 at 12:47 pm

ajay @ #9 said:

Economy’s been growing for the last five quarters, private sector employment’s been rising for the last nine months. Now, better policies could have made this happen better and faster and more, but it’s still not crash-and-burn.

Actually the US’s FY 2009-10 growth rate of ~2%, off a low base, is a bit better than my initial impression. So it looks to be a long drawn out soft-landing more than crash-and-burn.

To be sure, its a bit early to say what the US’s future growth path will be. But the anemic recovery does not inspire confidence. Private sector employment is obviously not growing fast enough to soak up secular growth in the labour force. Hence “jobless recovery”.

Basically the US has to dig itself out of a big solvency crisis, typified by its slumping housing market. So there are lots of assets out there which are slowly dissipating. Meanwhile the debt just keeps accumulating.

On the asset side: In previous down-turns the US has always found a spring board to growth. But there does not seem to be any productivity miracle in the offing. And new international markets ripe for plunder are already falling to the PRC and IND.

On the liability side: And now it has a millstone of private and public debt hanging around its neck. Households, firms and state governments are spending at low-rates relative to this stage of the cycle. Thats because any economic windfalls that come their way have to be used to amortise debt.

The Fed can stave off disaster by printing money, which can help to make ends meet and prevent a liquidity crisis. But this is not the basis for a dynamic self-generating economy.

Perhaps the US’s famed entrepreneurs will one day awaken from their doldrums and again amaze the world with a vigorous display of “animal spirits”. Unfortunately far too many of them have been enterprising in the financial markets, where innovation tends to be counter-productive.

15

MPAVictoria 11.04.10 at 1:20 pm

With interests rates so low there is no reason for the Government not to go on a building binge. We should be laying fiber optic cable to every city and town, investing in green energy power plants, rebuilding roads, improving public transit, ect. I know that this won’t happen, but it is what should happen.

16

Anderson 11.04.10 at 1:26 pm

With interests rates so low there is no reason for the Government not to go on a building binge. We should be laying fiber optic cable to every city and town, investing in green energy power plants, rebuilding roads, improving public transit, ect. I know that this won’t happen, but it is what should happen.

Exactly right, and very depressing. Americans are so insular that we tolerate pretty lame infrastructure because, well, that’s how it is, right?

17

Zamfir 11.04.10 at 1:52 pm

I don’t follow DeLong or Quiggin. Corporate bonds, commercial loans, home mortgages, etc., all price off the T-bond rate, so driving that rate down drives all the other rates down too. The $7 billion number doesn’t seem like the right measure.

That’s exactly the point: that 600 billion is a drop into that ocean of bonds, and will drive down rates by only a very small amount.

Look at it this way: QE replaces bonds in the market by new zero-interest cash, and the interest rate indicates how much more people currently prefer holding spendable cash instead of bonds that can only be spend 5 years later.

If you look at very short-duration bonds, they have nearly zero interest: at the margin don’t want to spend the money anyway, so they don’t care whether they have cash or bonds. Quantitative easing has no effect there, because bonds and cash are seen as almost the same.

For these 5-years bonds, the difference is not zero, but still small. The 7 billion indicates how small: it’s what the market is willing to pay to have 600 billion of cash instead of 600 billion of bonds.

The low rate indicates that people currently see 5-year bonds as almost the same as cash, so you need to replace a lot of bonds by cash to make a difference.

18

R.Mutt 11.04.10 at 5:34 pm

With interests rates so low there is no reason for the Government not to go on a building binge.

Why not just build the stuff with the new money and pay zero interest?

19

zamfir 11.04.10 at 5:58 pm

R Kutta, the government now pays interest to the fed, who turns its profits back over to the government. So it’s the same.

The reason to do it this way is to split two choices: the size of the deficit is set by the political system, but whether it is paid for by loans or printing is done by technocrats. It is a system that worked well for decades, but whether it is still the right system is a question beyond my pay grade.

20

Lemuel Pitkin 11.04.10 at 6:18 pm

Corporate bonds, commercial loans, home mortgages, etc., all price off the T-bond rate

They used to. Not any more.

21

Steve LaBonne 11.04.10 at 7:40 pm

Why not just build the stuff with the new money and pay zero interest?

That would be soc1alism. Can’t have that, now can we.

22

Charles St. Pierre 11.05.10 at 2:06 am

Brett Bellmore @11
And everybody:
Catch:

http://www.youtube.com/watch?v=vVkFb26u9g8&feature=related

“Money as Debt:” An eye opener. Really clarifies the money-debt issue, and why debt is only going to get worse. Why it can only get worse.

23

Charles St. Pierre 11.05.10 at 2:10 am

oops: http://www.youtube.com/watch?v=vVkFb26u9g8&feature=related
Money as Debt. This link is active.

24

nnyhav 11.05.10 at 3:52 am

LP@21 broken link; actually the corps et al price off swap rates these days so there’s some merit to the argument but swaps in turn price off trsys[1]. One effect sought in concentrating purchases in the 3-10yr maturities is to encourage corporate issuance (which the Fed ain’t buying unexigently) at lower absolute levels. And since the proposal was floated in August, rates both trsy and corp etc have sunk.

[1] which at 10yrs went to its widest in 2010 but the range has been confined between -5 and 15bp

25

James Kroeger 11.05.10 at 10:00 am

The interesting thing re: this topic, that no economist [my guess] has paid much attention to is the fact that the Fed could have done all of this imaginative intercession in the financial sector of the economy back in 2008, bailing out the banking/insurance sector by simply buying up every sort of paper available in the financial markets. If it had done so in a timely fashion, like earlier in the Spring of 2008, it could have prevented much of the debacle that followed.

If the banks had been allowed to write off their worthless paper holdings at a ‘manageable pace’, the Fed could have simply bought up all kinds of debt and paper assets at the same time and bank reserves across the country would have been maintained at acceptable levels. All the dollars spent on those assets would have quickly found their way into the loanable reserves of banks everywhere, repairing their balance sheets.

It would have had to buy up trillions of dollars of worthless paper, at a level far exceeding the current level of QE, but doing so would have actually been no more unacceptable than what the Fed is doing today. It is outrageous, but I doubt there are more than a few economists in NA that would be willing to point the finger at the Fed and say “they should not be allowed to do this!”

I would argue that the only reason the Fed did not do this “bailout” all by itself was because it/they feared the political backlash that might ensue, if they were they to act so boldly and obviously re: their ultimate purposes, which had little to do with the public interest, but a lot to do with protecting the interests of the financial elite. They were willing to allow the country to suffer through a severe recession in order to make its immoral agenda seem ‘necessary’ in some way.

Apparently, the Fed collective agreed that it could not act on its own, in such an unprecedented way, unless it had some political cover. Congress would be willing to give the Fed permission to use ‘extraordinary’ powers if it also had a big role to play in ‘saving the economic system from utter collapse.’ Clever, very clever.

26

Zamfir 11.05.10 at 10:21 am

Apparently, the Fed collective agreed that it could not act on its own, in such an unprecedented way, unless it had some political cover.

That’s the essence of democracy, right? That parts of the state need “political cover” before they can do big, unprecedented things?

27

James Kroeger 11.05.10 at 11:54 am

Zamfir:

That’s the essence of democracy, right? That parts of the state need “political cover” before they can do big, unprecedented things?

I’m not quite sure what you mean by this statement, but the Fed is not ‘part of the state’, actually. It is a privately-owned entity, and is thus a part of the private sector. It has authority sanctioned by and limited by Congress, but it essentially serves the commercial banking industry.

Yes, they are careful to promote the idea that they are part of the government, but they actually are not. The Fed truly is “the Bankers’ [Central] Bank.”

28

Guido Nius 11.05.10 at 12:30 pm

So the Fed has a dotted line to Congress. Neat!

29

Zamfir 11.05.10 at 12:55 pm

James, the Fed is not “owned” by anyone. It’s pretty close to a foundation. But its profits go the US state, which also appoints its leadership, sets its goals and has a right of oversight.

In Sweden, most of the public sector is connected to the government in a similar way. Strangely, no one thinks that Sweden has such a small state.

30

James Kroeger 11.05.10 at 1:13 pm

Zamfir 29,
James, the Fed is not “owned” by anyone. It’s pretty close to a foundation. But its profits go the US state, which also appoints its leadership, sets its goals and has a right of oversight.

I’m not sure why you’re saying this. The physical assets of the Federal Reserve are in fact “owned” by commercial banks, and by no others. When the Fed was created, commercial banks were required by law to buy those shares.

The Fed receives no funding whatsoever from the U.S. government. In contrast, actual government entities are funded by tax dollars, or dollars borrowed by taxpayers. After its profits are used to pay all of its costs, the ‘excess’ is handed over to the U.S. government.

Why these facts move you to declare that the Fed is not “owned” by anyone is a mystery to me.

31

Zamfir 11.05.10 at 2:14 pm

The Fed receives no funding whatsoever from the U.S. government.
That’s pretty similar to the way a state oil company is funded: the company gets a valuable right from the government (to drill for oil, or to literally print money and buy assets with it), subtracts its expenses from the profits, and hands over the rest to the government.

Note that the “stock” of the federal reserve banks doesn’t have any ownership rights associated with it. It doesn’t give a claim on the profits (only on a fixed dividend) and it doesn’t give a vote in the control. It only gives a (non-proportional) vote in the choice of directors of the regional banks, but those directors are subordinate to the Board of Governors, which is officially a government agency.

So the terminology is simply misleading. Banks own ‘stock’ in the Federal Reserve banks, they get ‘dividend’ and appoint some of their ‘directors’. But the stock isn’t like normal stock, the dividend is not like dividend and the directors are not the highest rung of the hierarchy.

Doesn’t mean banks have no influence, just that the stocks are not the channel of influence. European banks have lots of influence on the ECB too.

32

ajay 11.05.10 at 3:27 pm

So the terminology is simply misleading. Banks own ‘stock’ in the Federal Reserve banks, they get ‘dividend’ and appoint some of their ‘directors’. But the stock isn’t like normal stock, the dividend is not like dividend and the directors are not the highest rung of the hierarchy.

Exactly right. Saying that banks “own” the Fed is more wrong than not; they can’t sell their stock, they can’t sell off Fed assets, they don’t get a true dividend, they can’t buy more stock, and they don’t control the Fed’s actions. All these things would be true of, say, a bank that owned another bank.

33

y81 11.05.10 at 3:56 pm

“actual government entities are funded by tax dollars, or dollars borrowed by taxpayers.”

That is by no means true as a universal proposition: there are plenty of turnpike authorities, bond issuing agencies, etc. which are self-funding, but which are definitely “government entities.”

34

James Kroeger 11.05.10 at 8:57 pm

Zamfir 31:

Note that the “stock” of the federal reserve banks doesn’t have any ownership rights associated with it.

I don’t disagree that it is misleading to proclaim that the Fed is a private sector entity just like any other private sector entity, but it is equally misleading to proclaim that the Fed is an entity of ‘the state.’ Surely you’re not denying that the stated purpose of the Fed founders was to give it independence from the state?

From the perspective of the banker class, restricting the government’s appointment of the BOG’s seven directors to only one every two years, effectively gives control of Fed policy (subject to the limitations set by Congress) to the commercial banking industry. This, because any true ‘reformer’ that an American President might appoint, would find herself a very small voice within the collective.

Add to that the fact that the banker class has been successful in convincing both Congress and the executive branch that the workings of the central bank are so arcane and mysterious that only appointees from within the banking profession, or economists completely sold on the Fed’s virtue as an institution, would be ultimately acceptable to ‘the financial markets.’

What you end up with is a central bank that serves the interests of, above all else, the commercial banking industry in particular and the financial services sector of the economy in general. They know this, which is why they are so zealous to protect their “special arrangement” with the government.

The Fed’s “independence” is from representatives of The People; it is not independent of the will/desires of the financial services sector of the economy. It exists, rather, to advance their interests, as they collectively see it. That is why it is so important to them to have some political cover when they want to do something dramatic to save their asses from the consequences of their reckless gambling instincts.

What this central bank design has not done is protect the American economy from the consequences of reckless banking practices, driven by profit-lust. We had our ‘independent’ Fed, which was supposed to obviate the occurrence of financial cataclysms, but then we still ended up The Mother of All Financial Panics.

The Fed’s designed ‘independence’ failed to protect the public from the consequence of profit-lust withing the banking community. It does not work [for the public's interest]. It works only to protect society’s wealthiest gamblers from the consequences of their irresponsible behavior. It should be trashed and replaced with a new creation modeled after some more successful paradigm, perhaps the PBOC?

35

Bolt 11.05.10 at 11:51 pm

” (I am more than half convinced that Bernanke and some others on the Fed are partisans.)”

I’m convinced that Beranke and the rest are morons. Nothing works, because the haven’t a clue.

.

36

Martin Bento 11.06.10 at 12:38 am

The federal reserve system is nether public nor private, but a hybrid. Therefore, those who call it either public or private without caveat are wrong. While it is technically true that member banks have no say in the Board of Governors, the true power of the Fed is in the FOMC, and all 12 Regional Fed Presidents attend their meetings, and 5 of the 12 have votes (as do the 7 Governors). That’s almost half the votes and more than half the attendance selected by private interests. Who selects the Regional Fed Presidents? The regional boards, which have 9 members: 3 selected by member banks to represent their own interests, 3 selected by member banks to represent the public interest (ha!), and 3 selected by the government. That is to say, a majority of private bank control. It’s true that the federal governors can veto the appointment of a regional president to the FOMC, but how often does that happen? And the legal mandate of the President in choosing nominations for the Board of Governors is to balance various commercial and regional interests, not to serve the public interest. As the NY Fed website puts it:

“By law, the president of the United States must make appointments to the Board that yield a “fair representation of the financial, agricultural, industrial, and commercial interests and geographical divisions of the country.””

Policies that benefit the holders of wealth could benefit all those sectors, and all regions, at least in the low granularity of Fed measurements, while still being detrimental to the public interest. If so, the President is legally obligated to act contrary to the public interest in making his selections (though I don’t know what recourse there would be for a violation of this), according to the Fed.

And the Regional Feds can have considerable power in themselves. By all accounts, Geithner, as head of the NY Fed, was central to negotiating the bailout. Popularly, he is supposed to have been negotiating on behalf of the public, but he was actually given that position by people chosen by the (private) member banks.

Though both the claims that the Fed is public and that it is private are overly simple, moving into the normative area, I think the falsehood that it is simply public is more pernicious, as the problem with it (at least one problem) is that it is too attentive to private interests, not that it is too attentive to public ones.

37

MMT Proselyte 11.06.10 at 1:43 pm

Guys – a plea. It’s meaningless to discuss how big the deficit should be now or in the future, without reference to two concepts (1) sector financial balances (govt deficit is balanced by private sector delevering), and (2) fiscal sustainability (monetarily sovereign govts face inflation risk, but NEVER solvency risk).

Quiggin’s saying we should plan for fiscal consolidation down the road indicates he probably thinks of the govt like a household or business which needs to pay down its debt – this is Bretton Woods or Gold Standard thinking, and inapplicable in today’s era (unless you’re from the Eurozone or run a currency peg).

Strongly suggest this for starters: Introduction to MMT

MMTP

38

MMT Proselyte 11.06.10 at 1:48 pm

James/y81 – “actual government entities are funded by tax dollars, or dollars borrowed by taxpayers.”

I know it appears this way, but the US govt is not really funded by anything – it just spends by printing cash or more normally credit bank accounts. It then drains purchasing power by levying taxes. If tax < spending, the deficit will result in excess bank reserves; the Fed and Treasury drain these reserves by selling bonds. What appears a budget constraint is actually an ex-post accounting identity.

39

Martin Bento 11.06.10 at 8:27 pm

Looking back over the thread again, I see that zamfir and ajay imply the Fed is a mix of public and private, but claim it is more public than private. Let’s look at that.

First, the regional Feds. Banks own stock and get dividends, but these dividends are fixed, not variable like most stock dividends. According to ajay, this is not a “true” dividend. If it’s real money, it’s a real dividend. If I invested in a local business on the understanding that my share of the profit would be a constant amount each month regardless of actual profit, this would be unusual, and riskier than doing such a thing with the Fed, but no one would deny that I was engaged in a private enterprise for profit. The unusual nature of the dividend does not even move it closer to being a government operation. Also note that zamfir’s statement that the member banks do not have a claim on the profit is simply false: a fixed dividend is a claim on the profit, just like any other dividend. It is a limited claim, but to compensate that, it is without risk. The statement that the Fed turns its profit over to the government is also, for this reason, not entirely true.

And it is real money: 6% per year, without risk. What percentage of Dow stocks provide 6% in dividends per year, decade after decade, throughout the business cycle? Certainly not without risk. Why are the banks making a profit on a government entity that largely represents their interests anyway?

Nor do the restrictions on alienability matter. Employee stock ownership often involves restrictions on alienability; so do some forms of real estate ownership. No one calls these government ownership in consequence; it would be silly. A corporation that has a limited membership, sells stock only to those members in fixed quantities, and only allows sales back to the corporation? That’s my neighborhood grocery coop. A little unconventional, but clearly a for-profit private enterprise, not at all a government entity, nor, for that matter, a foundation.

As for control, I think I’ve already showed that the private banks have a substantial voice, not only in the regional Feds, but in the FOMC too. But let’s look at that more closely.

Suppose I want to control the FOMC, and I have a choice of the following two hands:
A) I appoint 7 of the 12 voting members and none of the non-voting. They then serve 14 years terms from which I cannot fire them. They have an explicit mandate to tell me to bugger off if they feel like it, and, in fact, take considerable pride in this.
B) I appoint 5 of the 12 voting members and all 7 of the non-voting. They serve 4 year terms, but only one year voting, so I can remove them in a reasonable time if they don’t do what I want. I also have the verbal influence of the non-voting members, giving me the majority of the people in the room. Anyone who’s been in a corporate meeting knows that the voting is not the whole story. Meetings are conducted in the medium of language.

“A” is the hand the public has; “B” is what the banks get. Which is the better hand? I would clearly say “B”. It’s not completely dependable, but it is more likely to get me what I want. If that is the case, then the banks have stronger control over the FOMC than the government, representing the public, does.

So I’m with James here. More private than public.

40

Zamfir 11.07.10 at 12:50 pm

Martin, the fixed dividend makes it, financially, a loan instead of ownership. Financial ownership of an organization implies that its profits and losses are yours, while a loan or fixed dividend is (aside from bankruptcy) independent from the balances of the organization.

That is not a technicality: it means that if the government donates a dollar to the Fed, the profits of the Fed will increase by one dollar and so the dollar returns to the government. So from the government POV, sending money to and from the Fed is effectively an internal affair. If a bank donates a dollar to the Fed, it still receives its fixed 6% and the dollar is lost.

On the cotroling side you are right: it’s complicated, and having a voice matters besides having formal rights. But I think you make too much from the independence: the public sector is not a pure hierarchy, and indepence from the central government doesn’t automatically make something less of a public organization. Courts for example are clearly public organizations, even if they get no orders from the government. The supreme court is even more independent than the federal reserve, but no one argues that itis a private organization, or that it is not part of the state.

Of course, that would change if the Fed was also part of private command hierarchies, and tied stronger to those than to the hierarchy of the state. This would be the case if the votes of directors where binding, which they are not. They are only recommendations to the board, which the board can in principle ignore. The board usually doens’t, but that is not formal control over the board.

Which, sure, gives a lot of influence over Fed decisions to banks, and influence can be power. Perhaps too much influence and power, I don’t know. But ownership is about formal control, not informal influence.

Ownership of the Fed is somewhere in between self-ownership (like a foundation) and government ownership, but definitely not ownerships by its stockholders.

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Martin Bento 11.07.10 at 10:13 pm

zamfir, the defining feature of a loan is expectation of repayment, and there is none here, so it is not a loan. The defining feature of ownership is control: it is the Regional Feds in which the banks hold stock, and they select two thirds of the directors of those institutions. That is definitely control. If the federal government transfers a dollar to a regional Fed, what happens to that dollar depends on whether the Fed has fulfilled its dividend obligation to its shareholders. If not, the dollar could indeed go to the banks, at least if they choose to press the matter. Furthermore, the claim of the banks on profit is actually much stronger than that of traditional shareholders. Ordinary dividends are discretionary on the part of the issuing institutions. They can choose to reinvest their profits instead, with “reinvest” defined very broadly: they could purchase a new fleet of company cars for executive use. The banks have a mandatory claim on the Fed. And, in fact, it is not true that in traditional public corporations, owners by definitions share in the profits and losses. You only share in the profits if the company chooses to issue dividends (and this is not purely theoretical; many do not), and the major purpose of the whole system is that you will not have to share in losses beyond your investment.

You don’t seem to acknowledge that the FOMC, not the Board of Governors, is the main place where Fed power in exercised, and that in the FOMC, the Regional Directors do indeed have binding, not merely advisory, votes, which the Governors cannot simply erase. If unanimous, the Governors could prevail, but the Directors do have real votes, and a large number of advisory voices in addition. In case there is any doubt as to where the power is in the Fed, let me quote a House Report:

“The FOMC, the Federal Reserve’s ,key monetary policy decision-making unit, formally meets eight times a year in Washington, D.C.[3] It oversees open-market operations, the principal tool of monetary policy which influences short-term interest rates and determines reserve and monetary growth. It also directs foreign exchange market operations of the Federal Reserve System. The FOMC is made up of the seven Board Members and five of the 12 Reserve Bank presidents.[4]. These presidents bring “grass roots” information to the meetings and, historically, have had relatively conservative voting records due in part to their insulation from political pressures.[emphasis added, and you notice the Directors lack of insulation from financial industry pressures is graciously unmentioned -M ]“

So the FOMC, not the Board of Governors, is the ball to keep your eyes on. And the Regional President votes there are real votes, not merely advisory. This paragraph neglects to mention that all regional presidents attend the FOMC meetings, not just the five with votes.

As you yourself wrote:

“Of course, that would change if the Fed was also part of private command hierarchies, and tied stronger to those than to the hierarchy of the state. This would be the case if the votes of directors where binding, which they are not. They are only recommendations to the board, which the board can in principle ignore. The board usually doens’t, but that is not formal control over the board.”

The counterfactuals here are actually true, save some details. The directors are chosen by the private command hierarchies of the member banks. Their votes in the FOMC are binding, not advisory. The Directors are tied more closely to the banks than the Governors are to the state because the long terms and avowed independence that deliberately curtail public control of the Governors have no equivalent for the Directors.

As for the Courts, the reason the question of private vs. public control doesn’t come up for them is that there is no private control. The Court system is not terribly democratic, and one could debate the merits of that. But there are no judges appointed by private actors, at least not not officially. And the highest court consists entirely of people appointed by elected officials. If the Supreme Court were like the FOMC, it would look like this:

1) 5 of the justices would be appointed as now.
2) 4 of them would by appointees of private for-profit corporations.
3) The public appointees would be, as now, for life, but the private ones would be for six-year terms. If the corporations accidentally put in Ralph Nader, they can correct the error, but the public gets stuck with Scalia for decades.

That looks considerably worse than what we have.

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Martin Bento 11.07.10 at 11:51 pm

I notice in the preceding that I got a little loose with terminology, referring to the Regional Presidents as times as “Directors”, when they are chosen by the Directors, but are called “Presidents”. I think my meaning is nonetheless clear, but if not I welcome any requests for clarification.

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Jack Strocchi 11.09.10 at 10:14 am

One thing that bothers me about Pr Q’s analysis (and De Long and Krugman) is that he makes no mention of the most important effect of QE: depreciation of the USD. There are so many extra USDs out there in global circulation that the price of existing USDs is now in serious decline. Which will certainly help US exports, following Eco 101.

The USD has been on a steady decline for the second half of the naughties. But the USD now seems to have broken through and stayed below the psychologically crucial 80 barrier after the first round of QE in late 2009.

Obama has certainly focused on export-led growth, from the get-go. And this seems to be having the desired effect on US exports which have been leading the recovery. US export orders are on the up and up.

So why haven’t Krugman, De Long and Quiggin focused on the USD? There are other blind spots in their analysis of the causes and cures of the GFC, most noticeably the attempt to downplay the role of Fannie Mae and Freddie Mac in promoting sub-prime loan fiasco. But the USD decline does not seem such an ideological hot potatoe.

What gives?

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Jack Strocchi 11.09.10 at 10:49 am

Here is a chart showing the USD index for the past 14 years, ie pretty much the whole post-Cold War internet boom and bust period. It repays study, from a superficial chartist perspective.

The USD’s long climb more or less peaked with the dot.com bubble in late 2000, when so much of the world wanted to buy USDs in order to catch a ride on the cresting wave of US capital markets. After 2000 the USD had a couple of bear market rallys after 911 but has been in steady decline from about 2002.

I have no idea what has driven the USD’s long decline – low-range QE by Bush? He has certainly overseen massive deficits and slashed interest rates. But I am not sure if there has been a long-term decline in US export share or overseas investment in US capital markets.

Can anyone enlighten me on this because I can’t be fagged trying to find the correct charts?

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Norwegian Guy 11.09.10 at 2:49 pm

Jack Strocchi, I think at least Paul Krugman have written quite a lot about this. See for instance:

http://krugman.blogs.nytimes.com/2010/10/16/a-fine-european-whine/
http://krugman.blogs.nytimes.com/?s=devaluation

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Zamfir 11.09.10 at 3:30 pm

I have no idea what has driven the USD’s long decline

For the most part, simply the early lack of trust in the euro when it was just introduced. Around 2000, a dollar was for a few years significantly more than a euro, because all the investors who used to buy European treasuries for safety switched to other things, mainly in the US. When the euro didn’t obviously collapse, the euro returned to roughly the same value its constituent currencies used to have.

So you see a rise in the dollar in the late nineties and early 2000s, and then a decline again. If you look only at the decline, you get a weird picture.

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Toyboat 11.09.10 at 5:23 pm

So to shift the subject a little, the current GOP are just economic terrorists, yes? Orrin Hatch even admitted before Obama even came into office that if the public sees Bush wreck the economy and Obama and the Dems come in and fix it, that’s the end of the Republican Party. So they have no option other than sabotage, and that’s exactly what they have done in the first 2 years of Obama’s presidency. Incredible.

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Martin Bento 11.09.10 at 8:36 pm

zamfir, you no longer seem to be arguing against substantial formal private power at the Fed. Have I convinced you?

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Zamfir 11.09.10 at 9:02 pm

Not really, it’s more that the over the thread the relevant structures have all been mentioned, and I’d say we basically agree on the actual power lines that exist. Whether you call the result public or private, or where you place ‘ownership’ is more a judgement call now.

To be clear, I don’t want to deny that banks have significant influence on fed decisions, not at all. I also think am not knowledgable enough to judge whether that amount is too much. Part of that is that I am not American. Fed decisions are relevant to my life, but whether they are made to the advantage of US banks or the US public is of less importance to me. The former might well be in my best interest.

Here in Europe, the ECB is undoubtedly a public institute, without any of the hybrid structure of the fed system. Yet it’s independece from politics is very comparable, and in practice banks appear to have a very similar voice in its decisions, even if there is less of a formal channel for that. Which is exactly why I am skeptical of claims that the fed is ‘private’: that implies that influence of US banks is an anomaly caused by the weird structure of the fed.

While in practice, the functioning of both the fed and the ECB seem very close to each other, and also to how the political process intended them to operate. If private parties have to much influence on their decisions, the solution lies in a wider political consensus to change that, not in specifics of the US system.

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