The Difference Between Quantitative Easing and Helicopter Money

I just read a report from a major international bank this morning(who shall remain nameless) that claimed helicopter money was already being implemented in a few countries, herein defined as monetary financing of fiscal deficits.

This is wrong, and they’re confusing quantitative easing (QE) with helicopter money (HM). The difference between the two is more than just semantics, despite the superficial similarities between the two in largely involving central bank buying of government bonds.

The easiest way to show this is via an example. Let’s say the private sector has $100. The government wishes to borrow $50 to finance its spending. So the private sector buys $50 worth of government bonds, the proceeds from which the government uses to spend on goods and services. But that money goes back to the private sector, so the asset side of the private sector balance sheet now reads $100 cash and $50 in bonds. The private sector balance sheet has expanded, as has the government’s.

Now that we’ve set the stage, we can work out how QE and HM affects the economy.

Low Interest Rates: It Isn’t Just QE

We’re nearing Fed “liftoff” with a better than 50% chance that the US Fed Funds Rate will rise above 0%-0.25% for the first time since 2008. But even taking into consideration the extraordinary monetary accommodation conducted by the major advanced economy central banks, interest rates globally have been in secular decline for very nearly 50 years, since the heyday of stagflation in the 1970s.

Money printing doesn’t half explain what’s going on.

The Fallacy of Composition and the Monetary System

I was tempted to be snarky about this, but that wouldn’t be fair, on laymen or anybody else.

It’s not easy thinking through economic problems, and monetary problems in particular. Slip ups are common, even among seasoned economists. It doesn’t help that standard texts on money and banking are badly wrong on how banks actually operate and how money is created. It’s no wonder then that people have a hard time figuring out what’s going on, and how changes in policy and customer preferences affect the monetary system.

Example 1 comes from a couple of weeks ago (excerpt):

How To Spin With Statistics: Compare And Contrast

From Jesse Colombo to the Dallas Fed (excerpt):

Asia Recalls 1997 Crisis as Investors Await Fed Tapering

The 2007–09 global financial crisis triggered unprecedented central bank policy intervention in the U.S. and elsewhere. The Federal Reserve, after cutting short-term interest rates to near zero, embarked upon three rounds of unconventional monetary policy known as quantitative easing, or QE. These measures involve the purchase of long-term securities and aim to stimulate the economy by lowering long-term borrowing costs…

Simple Nostrums For Complex Interactions: Details Matter

I'm quoting more than I usually do, because there are quite a number of fallacies to be addressed here (excerpt):

Rising tides of currencies globally
By DATUK ALAN TONG

A PACKET of nasi lemak (rice cooked in coconut milk) with a fried egg costs around RM2 nowadays. I remember getting a similar packet (and in bigger portion) at RM1 ten years ago. It is a 100% price appreciation in ten years! My friends and I were jokingly saying that nasi lemak would be a good investment tool if it can be kept for ten years...

…The global economies have been embarking on expansionary monetary policies since the financial crisis broke out in 2008. Central banks around the world are printing money to support their economies and increase exports, with the United States as the primary instigator.

Everything You Wanted To Know About Qualitative Easing

It took me a minute to realise that this new paper I was reading wasn’t a tract about Quantitative Easing, but about Qualitative Easing.

What’s the difference? Quantitative easing refers to the creation of new money that is then used to purchase risky bonds and other securities, thus expanding a central bank’s balance sheet and injecting liquidity into the financial system. Qualitative easing on the other hand refers to the purchase of risky bonds and other securities with higher quality securities such as government bonds or central bank papers. In this case, there’s no increase in a central bank’s balance sheet, and no additional injection of liquidity into the system.

OMG! QE3 To Boost Inflation…Not

The Federal Reserve Open Market Committee yesterday announced a third round of quantitative easing (excerpt; emphasis added):

FOMC Statement

…The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that inflation over the medium term likely would run at or below its 2 percent objective.

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative…

Basically, the Fed is committing to increase its balance sheet size by USD85 billion every month – sounds like a lot, but its actually only about a 11.3% expansion of the Federal Reserve system’s USD2.8 trillion consolidated balance sheet from now until the end of the year.

(Details in the Fed’s plans are available here).

Talk Boldly And Carry A Small Stick

The ECB has taken out its big guns, but conveniently forgot to take the safeties off (excerpt, emphasis added):

Introductory statement to the press conference
Mario Draghi, President of the ECB,
Vítor Constâncio, Vice-President of the ECB,

It is against this background that the Governing Council today decided on the modalities for undertaking Outright Monetary Transactions (OMTs) in secondary markets for sovereign bonds in the euro area. As we said a month ago, we need to be in the position to safeguard the monetary policy transmission mechanism in all countries of the euro area.

Gold, Quantitative Easing, And Property Prices In Malaysia

I read this over the weekend:

Applying the brakes – made for the short term – can be dangerous
FOOD FOR THOUGHT
By DATUK ALAN TONG

...Recently there has been a proposal to raise the floor price of properties for foreigners from RM500,000 to RM1mil to curb or control the prices of houses from increasing too fast. This proposal is on top of the other “cooling off” measures such as the 70% housing loan policy for purchase of a third property, the increase of real property gains tax from 5% to 10% imposed on properties sold within two years of the sale and purchase agreement, and the new ruling on housing loan limits based on net income rather than gross.

There is no doubt that the introduced “cooling off” measures have reduced the buying spree of properties. However, the intended objective of these measures to control the price of properties has yet to be seen. Introducing measures without critically identifying the root cause of the increasing property prices may instead create situations that would not be beneficial to the industry as explained by the theory of Risk Homeostasis.

So, what determines rising prices?

Quantitative Easing, ECB Style

From yesterday’s The Star (excerpt):

ECB spent US$18.8 billion on bond buys last week

FRANKFURT, Germany (AP) - The European Central Bank stepped up its emergency bond purchases last week to keep the eurozone debt crisis from infecting Italy and Spain. The move, however, was accompanied by a warning to governments that the support is temporary.

The 13.3 billion ($18.7 billion) purchases announced on the bank's Twitter feed Monday were double the 6.65 billion spent the previous week.

The bank has been buying Italian and Spanish government bonds since Aug. 8. The purchases hold down the interest yields on the bonds, and have kept bond market turmoil from pushing those countries over the edge while European political leaders struggle to come up with more permanent fixes…

If you’re not clear what this means here’s a primer. In essence, the ECB is printing money – “temporarily” to use their term – to provide short term support to Euro area countries having trouble refinancing their government debt. The ECB is also claiming that they’re “sterilising” their bond purchases, indicating that they’re also issuing their own debt to pull back the implied liquidity injection from the bond purchases into the Euro banking system. In short, if you net off the transactions, the ECB is providing it’s own more credible debt in exchange for the troubled debt of the PIGS.

Quantitative Easing Versus Printing Money

Ooooh, this one’s a doozy. I know quite a few people who will blow a gasket (make that: the whole engine block) reading this (excerpt):

Deflation, debt, and economic stimulus
Richard Wood

The US, Japan, and Ireland are suffering from deficient private demand, rising debt, and a tendency to deflation. This column is asks what can be done about it.

We begin by assuming that relevant authorities have decided that new money creation is necessary to work against deflationary tendencies and to stimulate the economy. The central issue explored here then is how should such new money creation best be deployed to create the required economic stimulus?

Quantitative Easing: Whole Lotta Nuthin’ Goin’ On

I’m still somewhat bemused that people ascribe all kinds of bad things things to the Fed’s quantitative easing. So far hyperinflation hasn’t happened, the dollar hasn’t collapsed, and civilization hasn’t come to an end. Once you actually look at the numbers, it’s pretty easy to understand why.

But first back to basics:

Revisiting Vision 2020 (Updated)

This morning I attended a speech by Tun Mahathir on the Vision 2020 that he introduced way back in 1991. The event was organised by the Institute of Marketing Malaysia (freebie plug here) on the subject of Vision 2020 and what progress we’ve made in achieving its goals.

The grand old man of Malaysian politics was in fine fettle, cracking jokes, most of which were at his own expense (like, having to reread the Vision 2020 document because he couldn’t remember what was in it, and making constant references to mega projects).

I want to touch on a few things he mentioned in his speech, some good, some not so much.

Currency Wars Part VIII: The Currency Rap

Ryan Avent sends us to Next Media Animation, to explain global trade and currency imbalances:

 

If you didn’t understand the Econbrowser post, this is the hip-hop version!

Econbrowser On The G20 Meeting

Menzie Chinn explains, in theoretical terms, about QE2, currency wars and capital controls:

Losing the Battle, Winning the War?

…I have also been thinking about the anger with which the policymakers and economists in the rest-of-the-world (as well as certain US politicians [5]) have greeted QE2 with. In some ways, the fact that they are angry speaks volumes about the effectiveness or ineffectiveness of QE2. (In other words, to criticize QE2 as having no effect, and then to be angry that it is being undertaken, are internally inconsistent views.)

My view is that anger at the US position is currently being driven by an understanding that QE2 has been surprisingly effective at depreciating the dollar, and that the rest-of-the-world has limited scope in countering that depreciation. In a game theoretic context, we usually think of competitive devaluation as a form of the prisoner’s dilemma, where the devalue option dominates the no-devalue option, and both parties end up with a devalued currency, but no net improvement because countries cannot all devalue against each other…

…However, because of the radically different post-recession economic conditions facing the US and China, the payoff matrix has changed. The US gains by allowing the currency to depreciate against the rest-of-the-world, but the Chinese (and to a lesser extent the other BRICs) have competing goals of maintaining rapid growth, high exports, and stable inflation. This point has become apparent as inflation has surged in China. [6] The conflicting goals Chinese policymakers face can be illustrated by reference to the Mundell-Fleming model. (See this post for detail)…

If you want to suss out the policy options that are facing the major economies right now, you could do worse than to read this.

QE2: Confusion And Chaos Reigns

I’m struck by the extent of the divisiveness of opinions that the Fed’s announcement last week about a further US$600 billion in asset purchases has raised. And then there’s the fact that the FOMC’s vote on the matter was not unanimous.

But to illustrate the chasm between opinions on the Fed’s “quantitative easing” (aka printing money) program, have a look at these two articles in Bloomberg:

Bernanke Can’t Use ‘Poison as the Cure,’ Burry Says

Nov. 5 (Bloomberg) -- Michael Burry, the former hedge-fund manager who predicted the housing market’s plunge, said Federal Reserve Chairman Ben S. Bernanke is trying to use “poison as the cure” by pumping more cash into the economy to spur growth.

Bernanke’s Fed pledged this week to use $600 billion in additional Treasury purchases to help lower a 9.6 percent unemployment rate, close to a 26-year high, and to avert deflation.

The attempt to bolster growth is reminiscent of Alan Greenspan’s actions to revive the economy after 2001, Burry said in a telephone interview from Cupertino, California. The former Fed chairman helped create an unsustainable boom in U.S. property prices with his policies, leading to the worst global financial crisis since the Great Depression, he said.

Boosting the economy “was the point of inflating the housing bubble,” Burry said yesterday. “It was the intent that the house would become the ATM machine, and help us through those rough times, post-dot-com, -Enron, -WorldCom, -Iraq and - 9/11. That’s why I say they’re using the poison as the cure.” …

Currency Wars Part VII: Jim Rogers Gets It Wrong Again

Well-known economist, academician, theorist, investor and author Jim Rogers says Ben Bernanke doesn’t know what he’s doing:

Bernanke ‘Doesn’t Understand’ Economics, Rogers Says

Nov. 5 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke’s decision to pump a further $600 billion into the economy shows his grasp of economics is weak, said investor Jim Rogers, chairman of Rogers Holdings.

“Dr. Bernanke unfortunately does not understand economics, he does not understand currencies, he does not understand finance,” Rogers, 68, said in a lecture at Oxford University’s Balliol College yesterday. “All he understands is printing money.”

“His whole intellectual career has been based on the study of printing money,” said Rogers, who predicted the start of the global commodities rally in 1999. “Give the guy a printing press, he’s going to run it as fast as he can.”

Currency Wars Part II

William Pesek of Bloomberg weighs in (emphasis added):

Currency War Is Solved With One Trip to Bangkok

Oct. 15 (Bloomberg) -- Those finance bigwigs blabbing away in Washington last weekend should visit Bangkok instead.

That’s where the “currency war,” which they naively believe they can avoid with their handiwork, is on display. Just as Thailand was on the front lines of Asia’s 1997 crisis, it’s being flooded by liquidity from Washington, Tokyo and Frankfurt.

On Oct. 12, Thailand removed a 15 percent tax exemption for foreigners on income from domestic bonds, joining South Korea and Brazil in curbing hot-money flows and currency gains. The former risks overheating, the latter threatens exports…

…Think of markets as a giant game of Whac-A-Mole. Officials from Beijing to Brasilia stand at the ready, hammers in hand, to whack down any spike in exchange rates. The trouble is, everyone is whacking at once. When everyone tries to tame currencies simultaneously, there will be few, if any, winners.

Currency Wars

Over the last two weeks, rhetoric has been building up over currency “manipulation” among major trading nations. The biggest target is of course China, with the turtle-slow adjustment of the CNY-USD exchange rate, but their far from the only ones. The Bank of Japan intervened in the Yen market in a big way last month, and Brazil, South Korea and Indonesia have instituted capital controls to a greater or lesser degree. Nor is currency intervention limited to emerging or Asian markets, as Adam Kritzer talks about in this blog post:

Currency War: Who are the Winners and Losers?

It’s still too early too early to say how far the currency war will go. The G7/G20 has announced that it will address the issue at its next summit, though it probably won’t lead to much in the way of action. Ultimately, politicians can’t do much more than shake their fingers at countries that try to hold down their currencies....

…That brings me to my final point, which is that all currency intervention is futile in the long term, because most Central Banks have limited capacity to intervene. If they print too much money to hold down their currencies, they risk stoking inflation…For Central Banks to successfully manipulate their currencies on the spot market, they must fight against the Trillions of Dollars in daily forex turnover. Eventually, every Central Bank must reckon with this truism.

Jim Rogers Is Wrong

Maybe its his Asian perspective, since he’s based in the East now, but calling for interest rate hikes in the developed world is about on par with implementing fiscal austerity in a recession…oh, wait, they’re doing that too:

Rogers Says China, World Should Raise Rates in Inflation Fight

China and other global economies should increase interest rates to contain a surge in inflation, said investor Jim Rogers, chairman of Rogers Holdings.

“Everyone should be raising interest rates, they are too low worldwide,” Rogers said in a phone interview from Singapore. “If the world economy gets better, that’s good for commodities demand. If the world economy does not get better, stocks are going to lose a lot as governments will print more money.”