Carlo's Think Pieces

Reflections of a Filipino in the Netherlands

Posts Tagged ‘quantitative easing’

Beyond the Debt Ceiling

Posted by butalidnl on 16 July 2011

The US is in the grip of the political drama around the raising of the debt ceiling. Economists are worried that if politicians fail to come up with a satisfactory solution, the US will go back into recession even if they finally agree on raising the debt ceiling.

Most Americans do not realize that solving the debt ceiling problem isn’t really the main issue. The main issue that they have to face is that the US economy is designed for the wrong century, and that it is long due for a transition to a more ‘modern’  design. Officials try to avoid the inevitable by artificially propping up the economy, but it won’t work. The transition will come. And it will be much more painful than a mere ‘double dip recession’ – it will make the recession of 2008 look like ‘foreplay’.

Transitions are alright in economics – the market will be able to recover and adjust the distribution of goods and services to adapt to any changes in the patterns of use. However, some transitions take long, and this means that the economy will suffer till the transition is over and the market has made the necessary adjustments.

The US is in the midst of three transitions: that of its housing patterns, the use of resources, and the US dollar. And since the nature of all these transitions is that they take a long time, I believe the US “crisis” will last for some time.

The government will naturally act as if it is only a matter of pushing through certain programs, and then the economy will recover. Perhaps certain programs may result in short term growth or increased employment. But this will ultimately be quite futile, and the longer term trends will overpower these gains.

 Housing
The economic crisis was caused by the housing bubble – specifically, the market for ‘sub-prime’ mortgages was oversold.  And this problem continues to this day, with homeowners continuing to default on mortgages. However, this is only part of the problem.  There is a creeping re-concentration of housing patterns in the US. People are not as willing as before to commute two hours or longer to work every day. This is partly due to the economic crisis – if you’re looking for a job, it is better to do so close to home. And, if your house is foreclosed, you would most likely move closer to the city for new and cheaper housing.

But the crisis only aggravates the problem, it did not cause it. Things like demographics (people getting older – and thus wanting to be nearer health care facilities) and the rising price of gasoline/diesel have a longer term effect on housing choices.

The movement of people from sprawling suburbs to smaller urban hubs means that many houses built in the suburbs will go unsold (or not rented) for a long time, and sometimes will only get sold at a very big discount. And the bad effect of this is that people won’t be that eager to buy houses in an area where house prices continue to go down. So, home building companies will lose money or even go bankrupt, until they completely shift their activities nearer urban hubs.

Expensive Resources
With the development of countries such as China and India (and of course, the rest of the world), there will be a squeeze to divide up all the resources needed. The days when Europe and America  could get away with using 80% of the world’s resources are over; and this means that the resources of the world should be shared more equally. And, this means that the price of most resources will go up significantly.

The resource that Americans  will really FEEL going up in price will be that of oil. From the crisis-level price of around $95/barrel, oil will surely go to $150/barrel by 2012. This is on the logic that if the world’s GDP returns to the pre-crisis level, so will the scarcity of oil, and this means that prices will return to pre-crisis levels. And that is only the beginning: beyond 2012, prices will rise even higher. Oil supply volatility may cause temporary peaks or dips in the price, but the overall trend is still for the price to rise.

For the American automobilist, this means that oil will return to highs of $5/gallon, or higher. This will need a permanent adjustment of living patterns. People will need to either commute less, ride trains or buses to work, or use smaller cars or hybrids.  And since oil is used for making things like plastics and fertilizers, the prices for these will also rise, forcing people to change their consumption patterns.

The rise in the price of grain, particularly that of corn, will eventually spell the end of feeding grain to cows.  At a certain point, the number of cows will be limited by the grass that they can eat. See High Corn Price Will Lead to Lower Beef Production Cheap meat will become a thing of the past.

Increased commodity prices will cause a move away from the throw-away economy. There will be a new emphasis on goods that last longer, and use less energy and other inputs.

The “Fall” of the US Dollar
The days of the US dollar as the international reserve currency are soon over. I would say that it would “fall” from this position sometime in this decade. And that the US economy will feel this change quite deeply. (see Two Years After the Fall )

The fall of the dollar finds its roots in the massive debts that the US has – almost 14.3 trillion dollars, to date. The Fed is even tried to stir up US inflation by ‘printing money’, or Quantitative Easing. And to make the problem worse, total US currency abroad totals $75 trillion.  The resulting inflation and the high amount of debt will be the dollar’s undoing; at a certain point, countries will decide NOT to keep dollars as reserve anymore, and NOT to buy up US treasuries, and this will drive up the interest rates on these treasuries.

Already, the rating agencies are threatening to downgrade the rating for US Treasuries from AAA to AA. While this seems like a small step, it will be the first push down the hill for the dollar.

The strength of the US Dollar rests on the willingness of other countries to keep dollars in their foreign currency reserves. Dollars make up to 80% of Central Bank reserves of many countries. Historically, this has meant that the US could buy more from other countries than it sells to them. If Central Banks’ change their mind regarding the desirability of the US dollar as a reserve currency (especially as a result of a change in Treasuries’ ratings), this will result in a sharp drop in the value of the US dollar. And  this point will happen sometime very soon.

After the Transition
After the decade of transition, the US will face a new period of sustained economic growth. The American people’s  flexibility and the country’s huge resources are sure bases for it to build a new prosperity.  Politicians should hurry the transition instead of trying to deny that it will happen.  They should not be distracted by the call to ‘preserve jobs’ or to ‘preserve our way of life’.

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Posted in Uncategorized, World Affairs | Tagged: , , , , , , , , , | 3 Comments »

QE2: A Formula for Disaster

Posted by butalidnl on 1 November 2010

The US Fed will soon decide whether to embark on a program of quantitative easing (QE2), which will mean that it will pump from $500 billion to $2 trillion dollars into the US economy, in the hope of stimulating it. This will be the second time in the recent past that it will do so.  In 2008, the Fed “created” $1.7 trillion, and used this to buy mortgage-bound securities, which nobody wanted to buy, and get the economy moving again. Now, with the economy growing at 2% and with 10% unemployment; the Fed wants to use quantitative easing again, in order to induce the economy to grow faster, and to lower the unemployment rate.

I think this is simply a recipe for disaster. In the first place, the “bubble” which burst in 2007 was caused by excessive spending, especially in the housing market. Now, the Fed wants to address the ensuing low growth by pouring money into the system. It sounds like the saying: “avoid hangover, stay drunk.”

US Centered
The Fed is playing with the idea of quantitative easing (QE2) because, for them, QE2 will stimulate the economy, and there would be minimal bad effects.  But this is because they only look at the short-term situation of the American economy. They do not realize, for one, that QE2 will have a detrimental effect on the US Dollar’s reputation the world over. They assume that the dollar’s prestige and acceptability all over the world will be the same even after QE2.

I think that this all depends. If QE2 is limited to say $500 billion, perhaps it may not have that much of a detrimental effect on the dollar’s prestige (though it is really going to be at the edge, I think). But if QE2 will be $2 trillion, then I am almost sure that there will be a chain reaction in the world that will turn around to bite the US back.

The US Dollar’s prestige throughout the world is declining, and since it is not an “ordinary” currency (but rather the world’s reserve currency) it needs to maintain a minimum of prestige and value for it to continue in its present role. That the dollar will remain as the world’s reserve currency is not a given; and I think that printing too much additional dollars will severely damage the image of the dollar.  And if this image is severely damaged, think of the consequences: what if the Saudi’s suddenly decide to take their currency off its US Dollar peg? What if this would lead to a substantial increase in the dollar price of oil? And what if the Chinese decide to get rid of their own US Dollar peg? These events are not theoretical; I’m sure the concerned governments are seriously thinking about it.

Money created through quantitative easing does not remain in the US. Hedge funds use this to buy fixed-interest assets in other countries, causing those countries’ currencies to rise in relation to the US dollar. And this will force these countries, sooner or later, to raise the dollar price of their exports, just to be able to maintain their profits. This will in turn mean that imported products in the US will cost more.

Even for the US
But even for the US, QE2 at this moment will be quite ineffective to stir the economy, and at worst will even cause more trouble. QE2 will increase the supply of money, but this will not do too much in the way of solving the problems with the housing sector. Increasing the money supply will not save people’s homes from foreclosure; and thus could not solve the problem of low consumer demand. People don’t spend as much because they fear they may lose their jobs or the houses, and I don’t see how pumping money into the economy will help this.

Sure, economic theory says that additional money supply could stimulate the economy, even the housing market. But this is true in a “normal” situation. Additional money, when provided at a time when banks are willing to lend, and when there is sufficient consumer demand (or industries are busy investing and hiring), will mean that the economy will grow faster than it otherwise will. But consumer demand and industrial investment will not happen just because there is money available; consumers and businesses should have at least a minimal level of confidence before they increase their expenses. This is like pulling a horse so that it is next to the river; nothing you could do could compel that horse to drink. If it is thirsty, it will drink. If not, there is no way that you can force it to drink.

But worse than being ineffective, QE2 could also do harm. For one, it creates an oversupply of bonds, which are fixed-interest instruments. This translates to low interest rates, which has a detrimental effect on pension funds and insurance companies. It also creates an artificial boom in the prices of stocks and even commodities.  The artificial boom in stocks will lead eventually to another stock market crash. And the rise in the price of commodities will mean higher consumer prices for the people.

QE2, by increasing the money supply, and through the mechanism of “carry on” trade (where people borrow cheaply in the US, and invest the money in fixed-interest instruments in other countries, taking advantage of the interest deferential, and possible foreign exchange gains) will devalue the US dollar. And this devaluation, some economic theorists say, will increase exports and decrease imports. True, it will. But it takes 18 months for exporters to gear up, and importers to adjust their purchases downwards. In the meantime, the balance of trade will worsen because exports remain the same, while the price of imports rise. And, in this world today, an 18-month gap is a long time; long enough to cause a downward spiral in the economy.

The inflation that the Fed wants to induce will come. The problem is that I don’t see how the Fed will be able to stop it when it comes. I don’t think that inflation will simply stop rising where the Fed wants it to. It will continue rising. And, if it is accompanied by low growth, that inflation will not be easy to eradicate. It will have become stagflation.

If the Fed realizes the full implications of quantitative easing on the US and world economy, I think they would think twice about using this instrument. Then, it will be the case of limited positive effect against a very dire possible negative effect.

The Fed would be well advised NOT to use quantitative easing at this time. Let the US economy grow at 2%. While this is low, it is a good basis for the economy to build on to achieve higher growth rates later. The US economy had been on a spending binge; let it recover gradually.

Posted in peso-dollar rate, World Affairs | Tagged: , , , , , , , , , | 2 Comments »

Euro Crisis?

Posted by butalidnl on 31 May 2010

These days, if you watch CNN (and most other American or British media) you would get the impression that the Euro is about to collapse as a currency; and that European countries will have to reinstate their old currencies. It is truly amazing how the Americans especially have fooled themselves into believing that – and now, they are panicking at the possible effect a fallen Euro will have on their investments.

Well, I think this is quite ridiculous; but don’t take my word for it, look at the facts.

Greece Crisis is Over
In the first place, the crisis with Greece is over. The Greeks have implemented deep cuts in government expenditures, and the rest of the Euro zone (and the IMF) are granting them enough loans to be able to rollover their existing debts for the next three years. After 3 years, Greece will still have a deficit, but this will be more manageable; and there would be enough safety nets in Europe to be able to ensure that Greece could rollover their debts easily by that time.

Structural Problems with Euro are getting addressed
In the meantime, Euro zone countries have put up nearly a billion dollars worth of loans and loan guarantees in a special fund to be able to aid other Euro zone countries who might come into trouble with their deficits and debts. This is a fund which is more than the US’ TARP funds that were used to save the US banking system. I believe that this fund is big enough for any problems Euro zone countries could face.

And then, the European Central Bank (ECB) has been given authority to buy up bonds from individual countries. This means that the ECB will in effect be doing “quantitative easing”, or printing money to be able to rescue member countries, if this is deemed as necessary. Of course, I expect that the ECB will use this new authority rather sparingly. The US Fed and the Bank of England has been using “quantitative easing” quite a lot these last couple of years.

In addition, various southern Euro countries have cut back on their expenses, way before the markets have any chance to attack them, like they did with Greece. In recent days, Italy, Portugal and Spain have announced new budget cutbacks (including cutting the salaries of Cabinet officials) , showing the world that they are taking serious steps to reduce their budget deficits.
And there are continuing discussions among Euro finance officials to set up a mechanism to ensure that countries do not exceed the 3% limit for budget deficits.

Panicky Americans
So, with the concrete causes of the crisis avoided, why are Americans panicking about the Euro? Well, I will attribute it to two things; first, it is to the interest of those who speculated against Greece or Spain to somehow make a profit. Rumours may not cause the bankruptcy of Greece or Spain, but they will maintain the price of their put options or Credit Default Swaps (CDS); the price of these will not go down as long as some people think that there is a chance of default.

And second, is that Americans do not understand the mechanics of European decision making. When Angela Merkel of Germany talks about the possible fall of the Euro, this may be true, but only in the long term. For domestic consumption, though, she would be quite grave about it, so that parliamentarians will be forced to support the various rescue programs etc. However, this is the way Europeans come up with common policy. European politicians are known for their brinkmanship, and their hyperbole especially towards domestic audiences. Then, they sit down together in marathon sessions, and viola – they agree on a solution, at the last minute.

We in Europe are used to this kind of brinkmanship and hyperbole of our leaders. We may be concerned about the Euro, but we know that most of the problems are on the longer term, and that our officials are well on their way to solving them. So, we don’t worry too much about it.  But Americans are a panicky lot – they think that the Euro is about to fall apart, that Spain is about to default, and as a result they withdraw their portfolio investments from Europe. This consequently lets the exchange rate of the Euro fall, and then the Americans panic even further – thinking (correctly) that this will decrease European demand for American products.

Well, Europeans don’t worry about their Euro falling apart any time soon.  True, the devalued Euro may make imports more expensive and make travel outside Europe costlier; but exports are booming, and imported products are low-priced anyway as it is, and they just need to plan their vacations within Europe instead of to more distant destinations.

So, for as long as it lasts, Europeans are going to enjoy the low value of the Euro. Of course, this can’t stay this way forever, especially with the growing surplus trade with the dollar zone. But it will be nice, for as long as it lasts. Actually, if I were an American, I will be well advised to buy European stocks or bonds now, while the Euro is still low; I will be sure to make a big profit in a year or so, when the Euro will be back to more “normal” levels.

Posted in World Affairs | Tagged: , , , , , , | 1 Comment »