Best of the Week
Most Popular
1. Climate Change Mass Extinction - Birds, Bees and Bugs: Going Going Gone - Richard_Mills
2.A Purrrfect Gold Price Setup! - Peter_Degraaf
3.Who Finances America's Borrowing? Recession Indicator for Independent Thinkers Part 2 - F_F_Wiley
4.America’s One-sided Domestic Financial War - Raymond_Matison
5.Gold Price Summer Doldrums - Zeal_LLC
6.Two Key Events Will Unleash Gold - Jim_Willie_CB
7.Billionaire Schools Teacher in NAFTA Trade Talks - Richard_Mills
8.Get Out Of Crypto Cannabis Bubble Before It Pops and Move Into Bargain Basement Miners - Jeb_Handwerger
9.Stock Market Could Pullback for 1-2 weeks, But Medium Term Bullish - Troy_Bombardia
10.G7 Chaos, Central Banks and US Fed Will Drive Stock Prices This Week - Chris_Vermeulen
Last 7 days
Gold Stocks Investment Wanes - 20th Jul 18
Diversifying Your Stock Investing Strategies is Smart Investing - 20th Jul 18
Custom Global Stock Market Indexes May Be Sounding Alarms - 20th Jul 18
S&P 500 Just 2% Below Record High, But There's More Stock Market Uncertainty - 19th Jul 18
Stock Market Technical Picture - 19th Jul 18
Gold Market Signal vs. Noise - 19th Jul 18
Don’t Get Too Bullish on Gold - 19th Jul 18
Bitcoin Price Rallies to Upper Channel – What Next? - 19th Jul 18
Trump Manchurian President Embarrasses Putin By Farcically Blowing his Russian Agent Cover - 19th Jul 18
The Fonzie–Ponzi Theory of Government Debt: An Update - 19th Jul 18
Will the Fed’s Interest Rate Tightening Trigger Another Financial Crisis? - 18th Jul 18
Stock Market Investor “Buy the Dip” Mentality is Still Strong, Which is Bullish for Stocks - 18th Jul 18
Stock Market Longer-Term Charts Show Incredible Potential - 18th Jul 18
A Better Yield Curve for Predicting the Stock Market is Bullish - 18th Jul 18
U.S. Stock Market Cycles Update - 18th Jul 18
Cayton Bay Hoseasons Caravan Park Holiday Summer 2018 Review - 18th Jul 18
What Did Crude Oil - Platinum Link Tell Us Last Week? - 17th Jul 18
Gold And The Elusive Chase For Profits - 17th Jul 18
Crude Oil May Not Find Support Above $60 This Time - 17th Jul 18
How Crazy It Is to Short Gold with RSI Close to 30 - 16th Jul 18
Markets Pay Attention Moment - China’s Bubble Economy Ripe for Bursting - 16th Jul 18
Stock Market Uptrend Continues, But... - 16th Jul 18
Emerging Markets Could Be Starting A Relief Rally - 16th Jul 18
(Only) a Near-term Stock Market Top? - 16th Jul 18
Trump Fee-Fi-Foe-Fum Declares European Union America's Enemy! - 16th Jul 18
US Stocks Set For Further Advances As Q2 Earnings Start - 15th Jul 18
Stock Market vs. Gold, Long-term Treasury Yields, 10yr-2yr Yield Curve 3 Amigo's Update - 15th Jul 18
China vs the US - The Road to War - 14th Jul 18
Uncle Sam’s Debt-Money System Is Immoral, Tantamount to Theft - 14th Jul 18
Staying in a Caravan - UK Summer Holidays 2018 - Cayton Bay Hoseasons Holiday Park - 14th Jul 18
Gold Stocks Summer Lows - 14th Jul 18
Trump US Trade War With China, Europe Consequences, Implications and Forecasts - 13th Jul 18
Gold Standard Requirements & Currency Crisis - 13th Jul 18
Focus on the Greenback, Will USD Fall Below Euro 1.6? - 13th Jul 18
Stock Market Outlook 2018 - Bullish or Bearish - 13th Jul 18
Rising Inflation is Not Bearish for Stocks - 13th Jul 18
Bitcoin Picture Less Than Pretty - 13th Jul 18
How International Observers Undervalue the Chinese Bond Market - 13th Jul 18
Stocks Trying to Break Higher Again, Will They? - 12th Jul 18
The Rise and Fall of Global Trade – Redux - 12th Jul 18
Corporate Earnings Q2 2018 Will Probably be Strong. What This Means for Stocks - 12th Jul 18
Is the Relative Strength in Gold Miners to Gold Price Significant? - 12th Jul 18
Live Cattle Commodity Trading Analysis - 12th Jul 18
Gold’s & Silver’s Reversals’ Reversal - 12th Jul 18

Market Oracle FREE Newsletter

5 "Tells" that the Stock Markets Are About to Reverse

The Fed Knew QE Wouldn’t Work From The Start

Interest-Rates / Quantitative Easing Oct 02, 2017 - 04:50 PM GMT

By: John_Mauldin

Interest-Rates

When is a mystery not a mystery? When Janet Yellen is puzzling over a lack of inflation, that’s when. So says Brian Wesbury, chief economist, and Robert Stein, deputy chief economist of First Trust, in the following essay (featured in my Outside the Box).

The bottom line: QE didn’t work—and Janet knew it was unlikely to work—from the start.

So where did all that easy money go? I think I’ll let the authors tell you. I think you’ll enjoy this brief, clear-headed essay.


The essay was sent to me along with a rant by my friend Tom Bentley. One of his paragraphs really rang a bell with me:

Here’s the real problem: “The Fed has never fracked a well or written an app. We understand that government bureaucracies want to take credit for everything.” They simply refuse to understand that government in a healthy economy must serve the needs of private endeavor, not the other way around. As taxes at all levels exceed 37% of GDP in the US, and over 50% in Europe, there should be no doubt why advanced country growth is lower than it has been since we’ve had advanced countries. Government typically makes a negative contribution to productivity—look at how much we have expanded employment in education (mostly by hiring more administrators), while educational outcomes have stagnated. The real travesty is, “[The Fed] is teaching an entire generation of young people, who in many cases don’t study economic history, that growth requires government intervention.” Helps explain why so many millennials are Socialists, victims of the massive indoctrination campaign conducted by the Democrat party. 

Now, on to the essay from Brian and Robert.

Low Inflation Is No “Mystery”

By Brian S. Wesbury, chief economist, and Robert Stein, deputy chief economist, First Trust
September 25, 2017

Last week at her press conference, Federal Reserve Chair Janet Yellen said that continued low inflation was a “mystery.”

She’s referring to Quantitative Easing (QE) and the lack of the economic evidence that it worked. The Fed bought $3.5 trillion of bonds with money it created out of thin air in an extraordinary “experiment” to avoid repeating the mistakes of the deflationary Great Depression. Milton Friedman was the leading scholar in this arena, proving the damage done by a shrinking money supply during the 1930s.

The money supply is a “demand-side” economic tool. A lack of money inhibits demand, while a surplus of money (more than the economy needs to grow) can cause inflation. The idea of QE (which has been tried unfruitfully for more than a decade in Japan) was to boost “demand-side” growth. And yet, inflation and economic growth have both been weak. In other words, demand did not accelerate.

So forgive us for asking, but after unprecedented expansion of banking reserves and the Fed balance sheet with little inflation, is it really a “mystery?” Or, is it proof of what we believed all along: QE didn’t work?

We get it. Just the fact that the US economic recovery started in 2009 and stock prices went higher is all some need to convince themselves that QE worked. But no one knows what would have happened without QE.

Back in 2008, even Janet Yellen knew there were problems with QE. During a December 2008 Fed meeting, she said there were “no discernible economic effects” from Japanese QE. Back then she was a Fed Governor and this was said during internal debates about whether to do QE. Today she leads the Fed and bureaucracies can never admit failure. So, the lack of inflation becomes a “mystery.” 

Conventional Wisdom is so convinced that QE worked, it can’t see anything as a failure. QE supposedly pushed up stock prices and drove down interest rates, while at the same time boosting jobs.

As for the lack of demand-side growth, the explanations are confusing. Yellen says low inflation is a mystery, others say it’s because of new technologies, global trade, and rising productivity. Slow real GDP growth is blamed on global trade, a Great Stagnation in productivity, and the lack of investment by private companies. QE gets credit for the things that went up, but things that didn’t are explained away, denied, or determined to be mysteries.

We have promoted an alternative narrative that agrees with the 2008 Janet Yellen—QE didn’t work. It flooded the banking system with cash. But instead of boosting Milton Friedman’s key money number (M2), the excess monetary base growth went into “excess reserves”—money the banks hold as deposits, but don’t lend out. Money in the warehouse (or in this case, credits on a computer) doesn’t boost demand! This is why real GDP and inflation (nominal GDP) never accelerated in line with monetary base growth.

The Fed boosted bank reserves, but the banks never lent out and multiplied it like they had in previous decades. In fact, the M2 money supply (bank deposits) grew at roughly 6% since 2008, which is the same rate it grew in the second half of the 1990s. 

So, why did stock prices rise and unemployment fall? Our answer: Once changes to mark-to-market accounting brought the Panic of 2008 to an end, which was five months after QE started, entrepreneurial activity accelerated. New technology (fracking, the cloud, Smartphones, Apps, the Genome, and 3-D printing) boosted efficiency and productivity in the private sector. In fact, if we look back, we are astounded by the new technologies that have come of age in just the past decade. These new technologies boosted corporate profits and stock prices and, yes, the economy grew too.

The one thing that did change from the 1990s was the size of the government. Tax rates, regulation and redistribution all went up significantly. This weighed on the economy and real GDP growth never got back to 3.5% to 4%.

Occam’s Razor—a theory about problem solving—says, when there are competing hypothesis, the one with the “fewest assumptions” is most likely the correct one.

The Fed narrative assumes QE worked and then uses questionable economics to explain away anything that does not fit that theory. It blames “mysterious” forces, both strong and weak productivity, and claims businesses under-invested. We’ve never understood the weak investment argument; why would businesses leave opportunities on the table by not investing?

Our narrative is far simpler. It looks at M2 growth, gives credit to entrepreneurs, and blames big government. After all, the US economy grew rapidly before 1913—when there was no Fed—and during the 1980s and 1990s, when Volcker and Greenspan were not doing QE. And history shows that inventions boost growth, while big government and redistribution harm it. Because it has the fewest assumptions, Occam’s Razor suggests this is the more likely hypothesis.

The Fed has never fracked a well or written an app. We understand that government bureaucracies want to take credit for everything. But in spite of record-setting money printing, inflation did not rise. Prices are measured in dollars, so if those dollars had actually entered the economy, prices in dollar terms would have gone up. They didn’t, which clearly says that money didn’t enter the economy and QE didn’t work as advertised.

Some say that’s because the money went into financial assets, but if that was the case, the P-E ratio for the S&P 500 would be through the roof. But because earnings have risen so sharply, the P-E ratio is well within historical averages based on trailing 12-month earnings and relative to bond yields.

We also understand that entrepreneurship is a “mystery” to some people because they can’t do it. Most people can’t change the world the way entrepreneurs can, but that doesn’t mean that by rearranging the assets of an economy in a different way, entrepreneurs don’t create new wealth.

By claiming that low inflation is a “mystery” the Fed is admitting it doesn’t understand the mechanics of QE. Yet, it is perfectly willing to allow people to think QE is what saved the economy. This is teaching an entire generation of young people, who in many cases don’t study economic history, that growth requires government intervention. The only “mystery” is why they would allow this to happen.

Get Varying Expert Opinions in One Publication with John Mauldin’s Outside the Box

Every week, celebrated economic commentator John Mauldin highlights a well-researched, controversial essay from a fellow economic expert. Whether you find them inspiring, upsetting, or outrageous… they’ll all make you think Outside the Box. Get the newsletter free in your inbox every Wednesday.

John Mauldin Archive

© 2005-2018 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules