Another Eulogy for Quantitative Easing

Sooner or later the Fed's innovative monetary policy tool, quantitative easing, will be retired. As QE wraps up there have been plenty of op-eds recently about its effectiveness. Perhaps one of the most persuasive op-eds about QE, however, comes from the man behind it, former Federal Reserve Chairman Ben Bernanke, who published an editorial in the Washington Post in November 2010 about what the Fed did and why. Back then I wrote a letter to the Washington Post (, which remained unpublished) that may well summarize my view on how effective QE has been. It follows below.

"I would like to comment on two of the channels through which quantitative easing is intended to support economic growth that Federal Reserve Chairman Ben Bernanke outlined in Thursday’s Post: lower mortgage rates and a rise in the stock market, spurring aggregate demand via confidence and a wealth effect.

According to the Fed’s 2007 Survey of Consumer Finances (SCF) only 5.5% of families in the lowest income quintile own stocks. The median value of these holdings is $3,800 (measured in 2007 dollars.) 10.7% of families in this income stratum have retirement accounts with a median value of $6,500. Compare this to 47.5% of families in the highest income quintile who own stocks with a median value of $75,000 and almost 90% of families with retirement accounts with a median value of $200,000 (Table 6B). Similarly, around 15% of families in the lowest income quintile hold a mortgage. The median value of these mortgages is $40,000 while over 75% of families in the highest income quintile hold a mortgage with a median value of $201,000 (Table 13B).

Some Quotes from Der Spiegel

Some quotes from Der Spiegel that elucidate German sentiment on the whole Eurocrisis:

Two interesting quotes from an interview with Jens Weidman, President of the Bundesbank. Emphasis mine:


SPIEGEL: Are your alternatives truly realistic? As the example of Greece shows, a return to self-reliance and sanctions through interest rates is not an option. And stronger political integration requires a new contractual basis complete with lengthy parliamentary processes, and possibly even constitutional amendments and referendums.

Weidmann: I think both approaches are feasible in principle, which doesn't mean that they're easy. The second option does indeed require time-consuming changes to the European treaties and national constitutions. It's important to take these steps in the right order and not to introduce the common liability part now, which might be more convenient for some, just because political integration is expected to occur at some point in the future. But I also feel that it would be promising, contrary to many prophecies of doom, to pursue a path returning to the origins of the real framework. It has to be strengthened, however.

SPIEGEL: What exactly would happen if Greece were not to fulfill the conditions for the next tranche of aid payment? Would Greece no longer receive any money at all?

Weidmann: Part of the regulatory framework of the monetary union is to uphold agreements. This means that Greece must live up to its commitments, and that there will be no aid payments if these promises aren't kept. Otherwise we would be setting false incentives.

From another Spiegel article:
"'If something isn't done immediately then no option will be excluded,' the Süddeutsche Zeitung on Tuesday quoted an unnamed euro-zone source as saying. An anonymous European Commission source told the paper that 'absent a strong troika report, we will see a national bankruptcy at the end of the month.'" 

Take on Berlin Elections

After a drubbing in regional elections in Mecklenburg-Vorpommerania, Angela Merkel’s party lost out in Berlin regional elections over the weekend as well. Berlin, in addition to being Germany’s capital, is also one of Germany’s 16 states. The states send delegates to the upper house of German government (Bundesrat.) Larger states get more delegate votes for the upper house but not proportionally so that smaller states end up getting disproportionately many votes in the upper house. The upper house is important (for e.g. Eurocrisis concerns) insofar as any law that is supposed to pass needs to get approved by the upper house.

The previous elections in Mecklenburg-Vorpommerania cost Merkel’s coalition 3 of the 69 votes in the upper house. Whether the 3 delegates Berlin has will go against Merkel’s government or only “sort-of” against it will depend on coalition talks. The following are the seats in the Berlin state government:

SPD and CDU are the two main parties with CDU being Merkel’s party. In order to get majority (and get to send delegates to the upper house) you need absolute majority. Both of the big parties will need to form a coalition with one of the smaller parties to get there. The most likely is that SPD and the Green Party (Grüne) do that. The only viable solution for Merkel’s party would be to form a coalition with the SPD--a so-called grand coalition--seeing that all other parties are more leftist than the SPD. This would be the “sort of against” scenario. That’s unlikely to happen because even if the CDU made real concessions the SPD can always just go with the Greens b/c even though there could be frictions, they are a much more natural coalition partner than Merkel’s CDU.

Right now the CDU is part of 39 of the 61 seats. It’s hard to say how exactly the cookie would crumble for any particular issue since the CDU e.g. has 8 seats in coalition with SPD and 19 seats in coalition with the Liberals who, after this defeat (didn’t clear 5% hurdle, see below) may wish to reposition themselves and might not go strictly along coalition party lines in issues e.g. pertaining to Europe.

The other main development is how dissatisfied voters in regional elections are showing themselves to be with mainstream German politics. The Greens winning an extra 7 seats in Berlin was seen as big. So was that the Liberals (FDP), a somewhat more centrist conservative party, did not clear the 5% hurdle and therefore got no seats in state parliament.

Even bigger, however, is that a complete newcomer party, the “Pirate Party” got 9% of the votes and garnered 15 seats in the Berlin government. The main issues the pirates are hanging their hat on are: more direct democracy (i.e. less representational democracy), free public transportation, unconditional minimum salary (unconditional on having a job or not), legalization of minor drugs paired with education about drugs in schools, and increased teacher-student ratio with a target of 15-to-1. While they are unlikely to be able to influence national politics and therefore are irrelevant for Eurocrisis concerns it is nevertheless telling that they beat out a mainstay party such as the Liberals.

All this means that Merkel needs to think about her constituency. Federal elections, which will determine whether Merkel gets re-elected, aren’t until 2013 and in that sense Merkel can ignore growing dissatisfaction with German-European politics for quite a while longer before it becomes acute. But this also clearly shows that sooner or later these dissatisfactions will become an issue for the Chancellor.

A Capitalist Case for a Progressive Tax System

Of course Warren Buffet's op-ed in Sunday's New York Times caused a lot of brouhaha. I tend to be surprised at how charged the debate about taxing the very richest income strata gets. Buffett is not talking about the rich in the sense that Obama has talked about them, i.e. anyone making more than $250,000 per year. While $250,000 is a lot it is not totally unheard of. A  lawyer, accountant, doctor, financial analyst, consultant at an advanced point in a successful career could well make that much money. Making $1 million every year is a different league. The majority of us don't know anyone making that much money. Yet I know many people who get upset at the proposal. It can't be a matter of self-interest that makes people feel this way so it must be a matter of principle. Yet the degree to which people feel this way seems incommensurate with other matters of principle. Whether it is incommensurate or not, here's why you would want a progressive tax system:

Turning Japanese...

...I think I'm turning Japanese, I really think so.

Below is a chart of the MSCI Japan and the MSCI US Indices except for lagging the US by 11 years.

It's striking of well the general shape of these two indices matches up. Could it be that the US is about to repeat the history of Japan? The chart gives a bit of a roadmap where the US equity market might head. In 1993 Japan found itself with a stagnating economy that forced it to cut interest rates eventually close to zero and keep them there for the next two decades (unless something changes drastically in the next two years.) Zombie banks were stalking the land and debt reached new highs.

At the mercy of commodity booms

Dani Rodrik's new Project Syndicate post "The Future of Economic Growth" is well-worth reading (as usual.) My favorite passage:

"But igniting and sustaining rapid growth requires something more: production-oriented policies that stimulate ongoing structural change and foster employment in new economic activities. Growth that relies on capital inflows or commodity booms tends to be short-lived. Sustained growth requires devising incentives to encourage private-sector investment in new industries – and doing so with minimal corruption and adequate competence."

I'm not entirely sure but I might go so far as to say that Brazil, for example (and definitely e.g. South Africa), is facing a challenge here. I am not sure how much economic transformation and diversification is going on in Brazil. However, seeing that Petrobras has been and continues to be the single largest company in the MSCI Brazil Index and the energy and materials sectors account for about 50% of the index, it seems that the country is still heavily reliant on commodities and the commodity boom to continue. Compare that with e.g. the MSCI Mexico, which has nothing in energy and 20% in materials and around 60% in consumer staples--a domestic-demand dependent sector--and telecom. Brazil might still be at the mercy of commodity booms and while its growth is strong and healthy it might also be less stable than one may think. What do you think?

Who bears the cost of fiscal austerity?

A friends sister recently posted some reflections on who bears the cost of various decisions on her (so far) excellent blog. She touched on the Greek fiscal crisis and I felt compelled to comment on who bears the cost of fiscal austerity measures. This was my reply:

In my opinion the costs are borne mostly by lower income strata. What typically happens during booms? Usually during booms higher income strata’s income rises more than lower strata’s. This, to some extent, is an artifact of the nature of booms. They are often engendered by technological innovations or people taking entrepreneurial risk and coming up with new products or starting new businesses. Think of e.g. the dot-com era. However, entrepreneurs are seldomly people on the lower rungs of the income ladder even during that particular time when some of the people coming up with new businesses were college kids. Similarly, technological advances seldomly make the most poorly paid workers so much more efficient that it would cause wages to rise. At this point working the McDonald’s register is as technologically advanced as it is likely to get–until those people are made completely redundant by some sort of fast-food ATM.