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John Hussman: The Recklessness of Quantitative Easing



October 18, 2010 – Comments (1)

John Hussman of puts out a Weekly Market Comment (which I highly encourage you to read every week). Per usual, this is another good article.


The Recklessness of Quantitative Easing
October 18, 2010
John P. Hussman, Ph.D.


With continuing weakness in the U.S. job market, Ben Bernanke confirmed last week what investors have been pricing into the markets for months - the Federal Reserve will launch a new program of "quantitative easing" (QE), probably as early as November. Analysts expect that the Fed could purchase $1 trillion or more of U.S. Treasury securities, flooding the financial system with additional bank reserves.

A second round of QE presumably has two operating targets. One is to directly lower long-term interest rates, possibly driving real interest rates to negative levels in hopes of stimulating loan demand and discouraging saving. The other is to directly increase the supply of lendable reserves in the banking system. The hope is that these changes will advance the ultimate objective of increasing U.S. output and employment.

Economics is essentially the study of how scarce resources are allocated. To that end, one of the main analytical tools used by economists is "constrained optimization" - we study how consumers maximize their welfare subject to budget constraints, how investors maximize their expected returns subject to a various levels of risk, how companies minimize their costs at various levels of output, and so forth. To assess whether QE is likely to achieve its intended objectives, it would be helpful for the Fed's governors to remember the first rule of constrained optimization - relaxing a constraint only improves an outcome if the constraint is binding. In other words, removing a barrier allows you to move forward only if that particular barrier is the one that is holding you back.

On the demand side, it is apparent that the U.S. is presently in something of a liquidity trap. Interest rates are already low enough that variations in their level are not the primary drivers of loan demand. Loans are desirable when businesses see opportunities to make profitable investments that will allow the repayment of the loan, without too much uncertainty. Similarly, loans are desirable when consumers see opportunities to shift part of their lifetime consumption stream toward the present (or to acquire durable items such as autos or homes which provide an ongoing stream of benefits), and where they also believe that their future income will be sufficient to service the debt.

1 Comments – Post Your Own

#1) On October 19, 2010 at 12:27 PM, rfaramir (28.67) wrote:

"liquidity trap"  what nonsense.  There is no such thing, and if someone uses that term, you know not to ever listen to them again.

He's right, though, of course, that this is not the barrier that will set people free to create value.  It's like pushing on a string.

Inflation of the money supply (QE or other forms) hurts savers, those on fixed incomes, and creditors.  It helps the printers, the fractional reserve bankers, and debtors.

The government is doubly in the second camp (printer and biggest debtor), so it loves QE.  Sneaky way to fund government largesse without obvious taxation.

The banks, though, are on both sides.  While they get to participate in creating checking account money from nothing, they become creditors in doing so, which they are afraid to do, as the debtors will be repaying with cheaper dollars (negative real return on investment).

QE is not the solution we are looking for.  Austerity (on the part of government), liberty, protection of private property, thrift, and common sense are.

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