What the Media Will Describe As QE Doesn't Make It So
A little over four years ago, the Bank of Japan started off the first arrow of Abenomics with a bang. The Japanese had, of course, experimented with QE in all but a few years of the 21st century, so to fulfill what Paul Krugman had long ago urged, the central bank would have to come up with something almost unbelievable. To many, it may have seemed they had done just that.
Japanese authorites gave the world QQE, the extra “Q” standing for “qualitative” as well as quantitative easing. It would have been better to have believed they doubled the number of “Q’s” more so for marketing purposes (now with double the Q’s!). The orthodox critique of monetary policy stuck in a liquidity trap was to go big, really big. If Japan was caught in this “deflationary mindset” as so many economists believed, and still do, the only way out was through the spectacular.
Krugman’s own argument was something along the lines of credibly promise to be irresponsible. The reasoning seems quite sound, for if you want the economy to truly take you seriously about generating inflation through money (as if there was another way) then threatening to go beyond all prior sense of propriety might appear to be sufficient. If you walk into a bank and meekly hand the teller an unclear robbery note, they might not get the message and likely not anyone else; if you burst in brandishing a rifle and screaming like a madman, then you are sure to get everyone’s undivided and obedient attention.
QQE was believed to be such madness. It would make the scale of trillions seem like rounding errors, where yen would now be counted in not the tens of trillions but hundreds. It would surely show who was boss in the monetary realm, and the boss wasn’t going to accept anything less than inflationary compliance.
BoJ chief Haruhiko Kuroda sure felt that way. In announcing his new credible irresponsibility on April 4, 2013, he beamed for the assembled cameras and declared, “This is an unprecedented degree of monetary easing. I’m confident that all necessary measures to achieve 2% inflation in two years were taken today.”
It was unprecedented for sure, but unprecedented what? The unprecedented program was altered at the end of October 2014, suggesting that though the Bank of Japan’s asset side of its balance sheet might get to a quadrillion it still wasn’t moving that way quite fast enough. Still inflation (CPI) in Japan went right back to zero, even negative again in 2015 and 2016.
In its latest meeting now thirteen quarters into QQE altered several times more (to add both negative interest rates early last year and now yield curve control later), the Bank of Japan once again has revised its inflation forecast. Initially, as Kuroda had said, the central bank allowed two years of irresponsibility to achieve a 2% CPI – and not just an occasional monthly print at or above 2%, but QQE was meant to continue until inflation stayed there in a show of seriously reckless conduct.
As of now, the Bank of Japan, which still forecasts 2% inflation in the future, as it always does, doesn’t think that will happen until around the end of 2019. What was to be just two years is now thought by those carrying out the madness to take about seven, at the earliest.
A truly rational person would observe all this and conclude there was no “monetary easing” unprecedented or otherwise. How could there be? Inflation is a monetary phenomenon, of that there can be no more doubt. If there is no inflation, then it stands to reason there was no money.
In writing about the opening of QQE all the way back in 2013, the media described anyway despite more than a decade of such Japanese experience with it already that what BoJ was doing counted in terms of “money printing.” From the Guardian in the UK:
“Japan's central bank has promised to unleash a massive programme of quantitative easing – worth $1.4tn (£923bn) that will double the country's money supply – in a drastic bid to restore the economy to health and banish the deflation that has dogged the country for more than a decade.”
That doubling of the “money supply” was estimated in the original two year time-frame. You don’t have to believe in quantity theory in order to figure out the problem. If the money supply doubles, inflation fails to follow, and further the economy contracts, did the money supply actually double? The only factor left in the so-called equation of exchange is velocity, and there is no way that it could halve and represent anything more than an error.
The mechanics of QE or QQE, with or without its recent financial accessorizing, are where a central bank buys an asset in exchange for a credit to the bank’s reserve account. That’s it, no more to it than that. What has happened is that convention, and popular imagination, assumed more than there is.
At the end of May 2017, BoJ reported for the first time slightly more than a half a quadrillion yen in assets. The various pacing of QQE from April 2013 through all that additional time expanded the central bank’s balance sheet by 187%. And yet, Japan’s M1 grew only by a total, not per year, of 27%; M2 by 15%; and M3 by not quite 13%. The broadest monetary definition in Japan, that of liquidity or L, increased by nearly the same. The progression in scale here is more than notable. As the monetary definitions progress further away from traditional formats, the lower the growth of the indicated money supply despite LSAP’s (large-scale asset purchases).
You can extend these growth rates all the way back to the restart of the parade of QE’s in December 2008 and find the same waterfall. Whereas M3 was expanding at a 0.27% compound annual rate in 2006, 2007, and 2008, in the year 2009 and after it has been growing at 2.67%. For L, the growth rate barely changed; from 2.02% to just 2.30%. Bank of Japan’s balance sheet was shrinking during those first three years, an annual rate of nearly -8%, while expanding by more than 18% compounded in the intensely renewed age of QE and QQE. Even assuming cause and effect, it still seems as if the central bank has to do a whole lot just to achieve, in the M’s and L’s anyway, not much at all.
Using just these mainstream monetary definitions, Krugman’s policy idea is surely being confounded by something. BoJ promised to do something momentous, but in the end that only applied to its own activities. Japan has been left instead with more blatant indications of Milton Friedman’s also late 1990’s reproach, where he felt it necessary to assert all over again the interest rate fallacy applied to Japan.
This misunderstanding of interest rates and bond yields was peculiar at the time, and remains so today. Low interest rates do not suggest “stimulus” of the monetary or any other variety. They instead indicate, unambiguously, a tight money condition. Thus, Friedman urged the Bank of Japan to go beyond its then world-first zero interest rate policy to expand the monetary base – which it then did, and now does at the rates shown above.
It seems perfectly clear, at least to someone outside the cult of Economics, that something isn’t right. The Bank of Japan did if a decade late follow both Krugman and Friedman and yet inflation is nowhere to be seen, and interest rates are as low as they have ever been. They all have run afoul of Alan Greenspan’s forgotten, often coded message. The monetary maestro of the 1990’s would often in the 1990’s pepper his speeches with concerns about monetary definitions and functions. There was more going on out there, he quite often said, than his or any other central bank had a handle on.
It has not been a Japanese problem alone. It can’t have been since the Federal Reserve and ECB both followed in BoJ’s footsteps.
Mario Draghi, the President of the European Central Bank, had at the end of this past June opened an ECB conference for central bankers in Sintra, Portugal, extolling what he characterized as a “global recovery” that is “firming and broadening.” The media took only those first two sentences of his address to be definitive proof of that happening, despite Draghi’s track record of, like all central bankers, making the same type of claim going all the way back to 2007.
What was left out of the mainstream descriptions was the far more important parts where Draghi admitted to a great contradiction, as he called it.
“An accurate diagnosis of this apparent contradiction is crucial to delivering the appropriate policy response. And the diagnosis, by and large, is this: monetary policy is working to build up reflationary pressures, but this process is being slowed by a combination of external price shocks, more slack in the labour market and a changing relationship between slack and inflation. The past period of low inflation is also perpetuating these dynamics.”
Earlier this week I provided a more accurate translation of this crucial part of his discourse:
“A more accurate summation of his speech is as follows: central banks navigate by inflation; inflation isn’t behaving no matter what we do; we don’t really know why; but we also believe that this ‘contradiction’ is temporary because we believe it is temporary.”
Should we be surprised the ECB is stuck in the same place as the Bank of Japan after the ECB used the same techniques as the Bank of Japan? And we can count the Federal Reserve in on this, as well. Though they are no longer doing QE apart from reinvesting maturities of securities long ago purchased, and are actually discussing winding down their balance sheet, they do so from the same position (interest rate fallacy) as the other two.
Whether the US, Europe, or Japan, the same “contradictions” are all applicable. Inflation remains below target whether a QE is in progress or not, and where it is to an enormous degree or something less. Further, bond yields are not just low but, for policymakers, mystifyingly so, indicating, as inflation, that monetary conditions out there in the unseen real economy are not at all like what we are told.
It is the further harmonizing of this majority piece of the global economy that should scare the pants off everyone; not in a crash-is-coming-tomorrow sort of way, but in the worse indicated state of global Japanification.
But the economy is expanding again, people will say in reply. To some degree, Mario Draghi is actually right; there is improvement in Europe, the US, and even Japan. But the fact that such improvement is not accompanied by normalizing behavior in these two major variables is cause for great concern. Draghi, as Yellen, downplays in public as often as he can the significance of all this, in favor of the boilerplate happy talk. But like Alan Greenspan in the 1990’s, you can read through enough of his speeches to cut straight through the sunny rhetoric to what is an otherwise unnerved and unsure central banker.
At its policy meeting yesterday, Draghi came as close as he might to outright stating it, saying, “there really isn’t any convincing sign of a pickup in inflation.” Where in late June he was “hawkish” this week he is supposedly “dovish”, when in reality he was at both times perplexed and anxious.
The fact that the economy is improving or not almost completely independent of inflation, interest rates, and monetary policy (or what Draghi was alluding to by raising a new argument for “changing relationship between slack and inflation”) is not a positive sign, but one more of this global Japanification. It indicates that any period of improvement will be painfully brief and utterly shallow, and then alternate with periods of worse than that. Becoming Japan is not a straight line from A to B. We are much closer to B than most people realize.
The global economy has since 2007 improved now four times including the most recent one in 2017. Each time it was described in the most glowing fashion possible at almost every juncture, yet in comparison each one has grown lesser at its respective peak. Recorded and measured economic momentum is weaker now than in 2013-14, which was less than in 2010-11, itself far less than 2007.
Yet, the aggregate balance sheet size of global central banks grows only larger throughout. You might make the argument from that inverse correlation that QE is itself a reductive economic factor (meaning that the end of QE will begin to fix the damage), but again the same experience in the US as Europe though one’s central bank is conducting QE and the other’s not argues instead that these monetary policies are post hoc reactions to monetary events and little more. They tell us only what the central bank has done, not what it can do (positive or negative).
Japan’s experience in the M’s is instructive for this difference. Each further definition is more expansive than the last, meaning in our terms here that monetary supply functions become harder and harder to easily describe. Money itself is a simple concept, but only at its results. The way in which monetary functions are met can be in the age of ledger money constrained only by imagination. Those that have been doing all the imagining have primarily been global bankers.
The difference between M1 and M3 in Japan is the addition of “quasi-money” (time deposits mostly, but including, importantly, foreign deposits) and CD’s. Japan’s L adds to M3 the holdings of pecuniary trusts, certain investment trusts, a small amount of bank debentures and bonds, as well as financial commercial paper. In other words, at each outer level the monetary definition attempts to address more comprehensive bank, and then non-bank, behavior. The further you get in those definitions from the central bank, the less the central bank matters no matter what it does.
The global economy has learned to meet its monetary needs by things that banks do, often in connection with non-banks. Defining money in this arrangement is challenging, to say the least, if not impossible. These transactions take place far outside of our perception (consider a very simple repo trade that is bilateral and bespoke, as most still are today; only the two counterparties engaged in it know it has happened and at what terms), often in the more esoteric conditions nowhere to be found on even the most thorough of accounting statements.
To try and address this evolution, the official monetary statistics have to always be enlarged (or, as US officials have done, abandoned entirely as with M3 or whatever might have followed it). The more monetary capacities are added and altered by institutions, securities, or methodologies lying outside even the broadest money definition at each interval, the less certain we can be of money conditions.
Thus, if the Bank of Japan buys a government bond, an equity share, or whatever, its crediting of that bank’s reserve account is useless without the bank doing something with it. In many cases, that bank can’t do anything, constrained as it may be by these hidden monetary factors. As the expanding monetary definitions demonstrate, more so as monetary growth rates fall as those definitions broaden, we see very clearly that whatever it is that governs bank balance sheet behavior will more accurately define total global money.
There remains far too much missing money, and often far too much central bank confidence that it doesn’t matter. Alan Greenspan used to worry that it did even though it wasn’t on his face every time he received any of his many slobbering accolades; he left that for Ben Bernanke and now Janet Yellen to address without nearly the same intensity and frequency of tribute. Mario Draghi has picked up finally on those same doubts if like Greenspan still under cover, leaving mostly Haruhiko Kuroda to play, as always, the straight clownish fool.
The central problem with Krugman’s endorsement, as Friedman’s, is the part about credibility, monetary credibility. That everyone in the media will describe QE as money printing, or even just rate cuts (or hikes) as stimulus (or tightening), is a given, but that doesn’t make it so. Central bankers have acted the prospective bank robber who bursts into the bank instead brandishing a banana after forgetting to put on pants. It’s still credibly irresponsible, but the results are vastly different.
