QE3

I am not an economist or anything close to it, but I do have some concerns about the QE3 program that seem legitimate even without deep economic expertise. I have two broad concerns, which interrelate with each other.

  1. ISTM that in general artificial distortions in the market are a dangerous thing. They create artificial disconnections, aka bubbles, which sooner or later must deflate. For example, right now it’s widely thought that both stock and bond prices are artificially inflated, bonds simply because interest rates are so low, and stocks both because the yields on competing investments are so low and because company profits are being propped up by very low interest rates. Other asset values are similarly thought to be inflated for similar reasons.

This does not guarantee that there has to be a sharp bursting of the bubble. The idea is to slow and reverse the program as the economy recovers and have the effects of the reversal be counteracted by the effects of the recovering economy. (Though frankly the way the market reacts sharply to the slightest hint at ending or not prolonging QE3 does not inspire confidence in a smooth landing.) But my point is just that it’s a potentially dangerous situation, which leads to …

  1. Economists don’t really know what they’re doing. I mean, they understand the economy a whole lot better than I do, to cite one example, and certainly understand some of the major direct effects of certain factors or actions, but in the end their track record at collectively predicting the future of the economy is pretty dismal AFAICT. You don’t notice this so much because they constantly revise their predictions along the way, so it’s not like they announce the economy will boom and next day a recession is announced, but by the time they finish with their revisions and the future actually comes, it doesn’t look a whole lot like what they were (collectively) predicting a few years back.

Unfortunately ISTM that this is exactly what counts when trying to figure out what the impact will be of major actions such as this one. They have to be right about quite a lot. They have to be right about what it does to the economy upfront, and they have to anticipate all the ways in which it might indirectly impact the economy, and they have to be able to anticipate how the unwinding of the program would impact things as well. Seems like a dangerous game to me.

Seems to me to be a lot like having a major surgery that’s completely experimental done by a doctor who really has only a vague idea of what the impact of his various actions will be. Only thing is that you’re already in mid-surgery and it’s too late to just call it off. Scary thought.

The problem is identifying what precisely is the distortion. Are QE3 and other unconventional policies the real distortion? Or are they the response to the general distortion in the labor markets that prevents the US economy from reaching its potential?

Without the unconventional policies from the Fed, it’s true that we’d have much lower stock prices and higher interest rates. And we’d also have unemployment in the double-digits for a proper second Great Depression. Is depression our “natural” state right now? No. It’s the very distortion we’re trying to avoid. Even with their purchases, it wasn’t the Fed that made investors go out and buy Treasuries at negative real interest rates. That came from the economic situation to which the Fed has been reacting.

There’s two kinds of predictions.

The first is straight-up guessing what will happen in the future. This is extremely tough, nigh impossible in fact, and that’s because new shit is always happening that interferes with the linear trends we think we see. Economists get these sorts of predictions wrong, get fooled by economic fluctuations, because pretty much everybody gets this wrong. There’s just no way to say exactly what, for example, the unemployment rate will be 18 months out.

The second kind of prediction is the conditional: if the Federal Reserve implements a certain policy, then this will be the likely effect of that possibility. And here we’re on much more solid ground, depending on our predictions. The Federal Reserve has been expanding its balance sheet by asset purchases, but for a starker example, we can imagine the actual printing of currency. If Bernanke actually climbed into a helicopter to drop trillions of dollars of legal tender on people’s feet, then we would see massive inflation. That’s an easy case, but that’s my point: there are plenty of easy cases out there that we can see plainly from the historical record. The conditions have to be right for them, but when that happens, we have a good chance of knowing what’s going on.

And I have to disagree.

While it is technically unprecedented, it qualifies in the most mundane way possible. The core issues aren’t anything new. More than that, the specific way in which they institute QE with asset purchases makes the whole thing reversible very quickly. They increase the monetary base by purchasing assets, which means they can decrease the monetary base back down by selling those very same assets. They push one button to start the process, then push another button to completely unmake what they’ve done.

And this is precisely why QE has had a negligible effect, considering the size of the numbers involved. If a genie shows up and gives you a trillion dollar bill, enblazoned with a picture of Arnold Schwarzenegger, and then promises to take away that bill the moment before you try to spend it, then your purchasing power hasn’t actually changed. It looks like you have a lotta cash, but the money doesn’t matter if it’s not going to stick around when you need it. This is much different from FDR’s actions in dropping the gold peg in 1933. That was a true irreversible action. We’re not even close to anything like that right now, and more’s the pity. 1933 was when the first strong recovery from the Great Contraction got underway.

The economy stalled again in 1937. Why? Because people were afraid that they’d gone too far. They plunged the country back into misery in their premature attempt to return to some myth of normalcy that didn’t actually exist.

In the US, quantitative easing has been going on and off since late 2008. Some non-economists predicted hyperinflation from the beginning. Didn’t happen. Some conservative economists, many of whom appear on TV warned of inflation 3 years ago. This is the sort of conditional forecast that Hellestal alluded to. Didn’t happen. And furthermore, none of them have revisited the issue, showing that they weren’t serious to begin with. Also recall that Japan did a little QE starting in 2001. No hyperinflation: in fact deflation didn’t go away.

Textbook economics has had a pretty good run I think. This is despite the fact that we’ve learned an enormous amount about macroeconomics in the past 6 years.

Nobody is fully correct all of the time. But serious people mark their beliefs to market when the empirics challenge their contentions.

OTOH, just because QE hasn’t done any real harm, that doesn’t imply that it’s done a lot of good. Here are 6 mechanisms by which QE operates (5 beneficial, one not). They are modest. DeLong notes though that warnings of tapering QE appeared to have some real effect. I’m not so sure and won’t be until the revised GDP numbers are released and the matter subjected to rigorous examination.

My POV, FWIW, presented w/o elaboration
I favor QE because I see little downside and uncertain upside. I also favor more vigorous steps to re-establish prosperity, ones with greater downside potential, though still modest IMHO. For example, aiming for inflation of the late Reagan era doesn’t seem like a big deal to me if it provides both short and long term benefits.

Thank you to Hellestal and Measure for Measure for your eloquent responses, helping place FRB policy in perspective. That massive central bank actions probably prevented another Great Depression is a very important fact that seems largely ignored.

Paul Krugman, among others, is worried that low-interest and high-unemployment are the new norm and will continue for decades.

I want to inject a slightly different perspective on QE stimulus and why it may be failing to stimulate.
[ul][li] Consumers will borrow to buy when interest rates are low … but America’s growing underclass have no cash and must pay huge interest on their loans, if they can get credit at all.[/li][li] Employers will hire when interest rates are low … but one of the most important employers of all, government, already stripped to the bone, is being forced to lay off more workers. IIUC, U.S. federal government just broke a 45-year record for fewest civilian employees. :mad: State governments are also “down-sizing.” Government is an essential employer for pure science, infrastructure maintenance, regulations, education, etc. But this sector is being squashed by political insanity.[/li][/ul]

I think it’s wrong to focus on monetary policy while government’s fiscal options are crippled by politics. Is today’s interbank interest rate really just 0.10% ? :smack: It can’t get a lot lower than that! Political sanity is what’s needed, not FRB tuning.

This is not about a cruise ship, I guess.

Well it’s a distortion in one sense in that it’s a deliberate attempt to manipulate the economy, versus the natural flow of events. But more importantly, it’s a distortion in that everyone including its proponents seems to agree that it can’t be maintained indefinitely and has to be unwound at some point.

I agree that there are two types of predictions but ISTM that if you can make one then you can make the other and vice versa.

If you can figure out the impact of any given factor on the economy given all the other factors already in place then you should be able to look at all of the factors in total and predict the future. If you can’t do the latter then the results of the interaction of the various factors are too much for you to predict and you can’t predict the marginal impact of any one either. Again, you may be able to predict part of the impact - generally an immediate direct impact - but the overall longer term impact is obviously beyond you.

I don’t think anyone is questioning that they technically can undo it very easily. Certainly I haven’t. The difficulty is in dealing with the effects of them undoing it.

[IIRC in the latest Fed minutes it appears that they themselves are beginning to get concerned about how to disentangle themselves without unsettling the market, but beyond the short-term effects on the market, it’s also the effects on the economy.]

It’s hard to know what the effects on the economy were, because it’s based on an assessment of what the economy would have done in the absence of these actions - which is yet more guesswork. I think a lot of people disagree with your assessment, FWIW.

This seems like a complete non-sequitor, AFAICT. I’m discussing the risks of the QE3 policy and you’re responding by attacking the predictions of some non-economists whose predictions - and themselves - have not been mentioned here and seem completely irrelevant to the issue. Perhaps I’ve missed something here.

They are not mutually exclusive though. To my way of thinking fiscal policy has known effects while unconventional monetary policy has uncertain upsides and modest downsides. That makes it a no-brainer. Setting aside a change in the nominal anchor or the long term inflation rate, which I think would be good ideas though in that case there are sacrifices. I think they are relatively modest, but I could sketch an opposing argument.

If it’s easy to unwind, then there’s no problem in carrying out the policy whatever you want to label it.

Ok, let me give you a thought experiment. Imagine a landlord of 20 office buildings. He’s having a discussion with a building and maintenance consultant who evaluates his… drippy faucets. The analyst shows his boss the tradeoffs between water usage and labor costs. Say it makes a difference whether you send a team to check and repair the pipes one time a year or 3 times a year.

In July an earthquake occurs, the pipes burst and the water bill goes up. In February the boss reviews the year-end statements and calls the analyst into his office. Does he chew him out because the water bill is several times the high end estimate? Of course not. The analyst modeled leaky pipes: he didn’t pretend to model earthquakes.

Similarly, no economist predicted the 1973 oil embargo or the 1978? Iranian revolution and the subsequent effects on oil prices and economic output. In 1977 they could tell what would happen if oil prices doubled. But predicting the next recession would have been beyond them.

See? Mainstream textbook economists understand some processes. They can distinguish between demand and supply shocks. But predicting the next recession is an entirely different matter. More deeply, most recessions between 1948 and 1999 were triggered by Fed tightening. If economists had a better grasp of things, the Fed wouldn’t have tightened as much and the recession wouldn’t have occurred. And indeed that is what happened during the mid-1990s Fed tightening.

I think economists have a pretty good grasp of the effects of conventional fiscal and monetary policy. But there are still things to be learned. For example, I assumed in 2005 that governments would love to run big budget deficits if given permission. The problem would be reining them back in after the crisis is over. But actually adopting a huge stimulus package is politically challenging. I was wrong and frankly I didn’t even see that coming.

The analysts I cited were opposing QE. Many of them were economists with mainstream credentials. (Some were merely unqualified political commentators.) It’s a little embarrassing actually. They tended to have a higher media profile though. Their petition muddies my argument, so I thought I would mention it.

In that sense, absolutely everything that a central bank does is a distortion.

In a more conventional time, any given interest rate that the Fed chooses also cannot be maintained indefinitely. If things heat up or slow down unexpectedly, then their policy will have to change. When rates go down, it’s likely that they’ll rise again. When they’re up, it’s likely that they will fall. Saying that the Fed will have to shift gears eventually is nothing new. The difference now is that they’re using the quantity of base money as a policy instrument, but the new instrument still functions by expansion and extraction. We should naturally think that there will be times when their balance sheet will expand, and other times when it should contract. That’s the nature of their new instrument.

There should be better reason than this if we’re going to use words with negative connotations. It can look like people are choosing the negative word first, and then only afterward searching for some rationalization to use it.

Their actions change the markets, but that in itself isn’t enough to fairly label their policies a distortion.

It’s true that the macro world is messy, the aggregate of all our behaviors put together. And yet there are times when amazingly strong relationships show up. The Great Depression is one of those times.

We can’t run a counterfactual history, but we can look at the immediate economic response to policies. This happened year by year during the Depression as they tried all manner of ideas that popped into their heads. FDR got a lot of stuff wrong, no doubt, but he also got a thing or two magnificently right, and the results were swift and strong and easily seen. The economic relationships can’t be dismissed as just some magic coincidence. The potential impermanence of QE makes it relatively harder to judge its effectiveness, but we still get clear market responses from unexpected Fed announcements, and it’s not a stretch to look at the market conditions the day before surprise news and compare to the day after. International comparisons are also illuminating, both modern and historical. There’s a reason that so much of Europe is in the shitter compared to the US, and a comparative look at the two monetary policies reveals a huge chunk of the reason why. We saw similar differences related to the speed with which countries abandoned their gold pegs in the 1930s.

There’s plenty we don’t know, but that’s not an excuse to ignore what we’ve genuinely learned. It’s not hard to see many effects, if we go out and look. Calling it guesswork doesn’t actually make it guesswork.

Completely true.

You say that M4M’s post was a bit of a non sequitur, but it actually sheds light on this very issue of disagreement. There are some very famous economists on that list, among other people, yet it turned out that they “disagreed” for very stupid reasons.

It’s possible that there are some people out there who have genuinely sophisticated reasons for their disagreement. Always have to be open to something like that. But all the cases I’ve seen have at best been people who make a plausible first argument, and then dig their heels in rather than update their beliefs when the cracks appear in their pet theory. I haven’t seen anybody on that list have their come-to-Jesus moment. They just come up with new reasons to keep believing the same old things.

Since there have only been two Queen Elizabeths, how can there be QE3?

Can I be silly too? :cool:

First of all, neither the famous RMS Queen Elizabeth nor the RMS Queen Elizabeth 2 was named after a ruling Queen of Britain. Each was named after King George VI’s queen, the mother of U.K.'s present sovereign.

And if you’re wondering about U.K.'s future sovereign, Queen Elizabeth III, this was already asked and answered two months ago.

I run into swampwater economists that seem to believe exactly that.

The politicization of economics is nothing new. One problem I see is that politics often determine which economists are the most influential so some economist become more political. I guess the same is true in a lot of areas.

Reinhart and Rogoff come to mind.

What is meant by distortion in this paragraph? I would say distortion occurs outside of non-coerced market exchanges. I would include money printing as a coercion because it is shuffling purchasing power from one group to another.

The fact that employers are not buyers of labor at this level is not a distortion. That’s like saying the market is distorted because I can’t sell VHS tapes for $20. VHS tapes are not worth what I am asking. Laborers are not worth what they are asking, so they should train for more productive occupations or accept the going rate for laborers.

That’s easy to say but impossible to prove. I could easily say the opposite. If we want to talk about the Great Depression, something to note about that period is that Hoover interfered in the labor markets early on and prevented workers and capitalists from adjusting to new lines of production.

Ok so a depression is a distortion? I would say that depression is the result of distortion (a depressed economy is a distorted economy). I think it is important for you to state your definition of distortion if you are going to use the word.

The very fact that the Fed is a major purchaser of treasuries is a signal to investors.

[QUOTE]
There’s two kinds of predictions.

What does the historical record have to say about the staying power of fiat currencies controlled by debtor nations?
And I have to disagree.

Ok I’ll put you down for $1 million in mortgage backed securities. The Fed is buying these assets at inflated prices. Any prediction on the worth of these assets once the Fed is no longer a major buyer but a major seller?

I have to be missing something here because you usually give good arguments. Once you have the trillion dollar bill it is yours. You don’t have to buy back your toxic assets.

What should interest rates be?

The Fed only directly controls the interest rates banks pay to each other - the “federal funds rate”. When a bank needs federal funds (money) this is the rate banks pay to get it. It is the cheapest possible rate, because banks generally won’t lend money at a rate less than the cost of getting it.

But banks can, and do, charge more - sometimes substantially more - to lend money to the public than what it costs them to get it. That’s how they make profit.

The federal funds rate, in other words, represents a floor, but not a ceiling.

So what should the federal funds rate be? 0.25%? 2%? 10%?

When people talk about “artificially” low interest rates, I don’t know what that means. Any federal funds rate is as artificial as any other.

The Fed does not control the stock market. Investors in stocks (as well as gold, real estate, art, tulip bulbs, Beanie Babies, baseball cards, and virtually any asset market you can think of) are perfectly capable of “irrational exuberance” regardless of what the Fed does.

It’s true that safe investments (like Treasury bonds) compete with riskier investments (like stocks). So more people will try to crowd into stocks (for example) when the yield on safer investments is low. But it’s also important to realize, that though many people make a lot of money trading stocks (stock brokers, for example) there is never any more money going into the market than coming out. At the end of the day, the money sellers of stocks obtain is exactly equal to the amount buyers pay (minus brokers’ fees, of course). Moreover, the buying and selling of stocks doesn’t itself produce anything; there is no product. No shoes, no houses, no widgets: nothing.

In other words, the Fed would do well to focus on the productive part of the economy. Right now there are literally millions of people who are out of work. They are people who would like to be building cars, or homes, or doing other useful productive things, but can’t find work. One million of them represent two billion man (or woman) hours of productive work that doesn’t get done. Things that would actually improve GDP (unlike the stock market) and that would make everyone (not just stock brokers) better off.

People who are investing in the stock market are (pretty much by definition) people who have more money than they need. The Fed should let them take care of themselves. If they don’t understand that stocks are risky, they shouldn’t be buying them.

There will always be bursting of bubbles (so long as there are people who want to get rich without working - which is pretty much all of us.) It is a feature (or maybe a bug) of capitalism. You can go back hundreds of years - well before there was a Fed, or even a United States) and see the same pattern over and over again.

No, economists don’t really know what they’re doing. No mainstream economist predicted 08 financial crash, for example. You would think they might want to go back and examine their assumptions, and their models, and the kind of work they’re doing. But that hasn’t happened.

How do you know it has " uncertain upsides and modest downsides"? That’s the central question here.

It’s easy to unwind from a technical perspective. It might not be easy to manage it without significant effects on the markets and economy. These are not the same.

ISTM that you’re claiming that mainstream economists can in fact predict the future absent shocks to the system from unexpected developments outside of the purely economic arena. I don’t think this is correct based on what I’ve seen over the years, but don’t have a basis to argue with you other than that. (If this is not in fact your claim, please clarify.)

To some extent that’s true. But the key question is whether it can be maintained.

ISTM that interest rates are fundamentally different. Because the Fed could in theory maintain low or high interest rates forever. The only reason for them to change it is because at some point it’s inevitable that this will cease to be the best policy. But there’s nothing otherwise limiting their ability to do this, per my understanding.

There’s absolutely some truth to this argument. What I’m doing here is expressing some unease due to the fact that throughout history situations that seem similar to this one have tended to end badly and I’m suspicious of the “this time it’s different” argument.

I noted above that the immediate and direct impact is easier to predict. It’s the longer term effects, and the ripple effect of these policies on myriad other factors which make up the economy which makes it harder.

The same would also apply to economists who support QE3.

Which would seem to support my argument that the ability of economists to predict the impact of these actions is very shaky.

ISTM that you’re trying to do an end run around this argument by declaring that certain predictions - despite having been made by “some very famous economists” - were “for very stupid reasons”, with the implication that we can figure out what’s going to happen by just eliminating all the obviously stupid predictions and going with what’s left. From my perspective, I don’t distinguish between some famous economists and others. It’s all one big pool of famous economists, and sometimes some are right and sometimes others are, and to the man in the middle, you just never know.

This - and the rest of your post - seems to be about the Feds setting the short term interest rates. This thread is about the Fed bond purchases.

There is a limit even to interest rate controls.

The image of most people is like they’ve got this giant interest rate lever, sort of like a gear-shifter in a car. The illusion is that they just push in the clutch, grab the stick, and move interest rates down a quarter percent. No. Don’t work like that.

The federal funds rate is a market rate for interbank lending. It’s the rate banks charge each other for overnight loans of reserves. There is a supply and a demand. The supply comes from the available monetary base that banks are willing to lend. The demand comes from sudden withdrawal and currency requirements from customers, as well as regulations like required reserves for deposits. It’s this market that the Fed steps into. They are the 800 pound gorilla of federal funds. If banks are charging each other a pound of flesh for overnight borrowing, the Fed can make more base and ease that burden. If banks are throwing reserves at each other for practically nothing, the Fed can step in and take a chunk of change out of the system. The rate can be pushed where they want it to be. But it is still a market.

And it’s very easy to imagine a case where they lose their gear-shifter. If their balance sheet gets blown totally to hell, for whatever reason, they’re not going to have any assets to sell to suck that cash out of the system. No balance sheet = no way to raise rates. I guess you could say that a given low rate could be kept indefinitely, even given high inflation, but that’s not really true either. It would require more and more irresponsible purchases as they pump money into the system, but you quickly reach a clear point of no return. There’s no way out of that trap. The amount of money they would need to keep rates low would increase exponentially. The very fast result would be hyperinflation. The federal funds market might still “exist” in that form in some regulatory capacity. But not really. All credit, even overnight bank lending, would cease to work as it does now.

Interest rates can’t be held indefinitely. They’re like balancing a tall pole on your hand on a slightly windy day. If you’re not compensating, the pole will fall, either to one side or the other.

I don’t understand the parallels you think you’re seeing.

The very first time a country instituted QE was Japan just a smidge more than a decade ago. They remained mired in deflation afterward. Their own fault. They raised interest rates, twice, when the policy might have lead to moderate positive inflation. It’s only with the election of Prime Minister Abe a year ago that they seem committed to an actual positive inflation target. Is this the result that “ended badly” that you’re thinking about?

Well, if you’re looking for people who can see clearly into next week, the first step might be to dismiss everyone who fucks up their prediction of tomorrow. There are other things to do, but that’s a good first start.

Only the ones who have been wrong, and haven’t admitted it.

If you’ve got a list of names of people who made a clear prediction about the positive effects of QE3, got their prediction wrong, and then kept saying QE3 was great for a different reason, then I’d be happy to read it.

For the record, I thought that QE3 would probably be mildly beneficial. It’s been mildly beneficial. (Don’t know if I have that written anywhere.) I would prefer the Fed announce a clear NGDP level target, and then cut the interest on excess reserves to 0% or possibly a negative quarter point, if they could get away with that without giving the money market peeps a complete shitfit. They don’t want to break the buck again, but really, preventing that is not now, nor should it be, the primary responsibility of the Fed.

People should listen to the best idea available.

I happen to think that best idea is a breed of monetarism, in the tradition of Milton Friedman. I could go on at length about that, but then, I already have in previous threads. It takes some explaining.

That’s completely understandable.

I look at it as a giant jigsaw puzzle that has to be explained one dismal piece at a time. There are a lot of schools, and each of them has their own favorite explanation. And really, each of the schools tends to truly understand the piece that they carry around. I haven’t come across a robust theory of economics that wasn’t right about one big important thing. But they don’t look outside their own box. They don’t put the pieces together.

Naturally, I flatter myself that I can see the whole picture. Of course I do. Maybe I’m full of it, too. But I do read the ideas of many different schools. I do keep myself open to other explanations. And any new explanation that’s going to be convincing has to incorporate all the important evidence – the data and the history and the trends that have already shaped monetarist thinking. Any new explanation has to be more robust than the one already out there. It can’t just be one single lonesome school with a single puzzle piece. It has to be a new intriguing way to put all the pieces together.

And there are a lot of pieces. That can’t be helped.

If I’m using the word distortion, I’m going to be using it in the economic sense.

That means that quantity supplied isn’t getting matched properly with quantity demanded. That might be because price isn’t flexible enough, as in the labor markets. Wages are sticky. There is a lot of empirical evidence on this: wages don’t fall as we would expect in other markets, not even during a recession. If you graph wage changes, you’re not going to get a normal distribution centered around a mean. At no change, a huge clump of data will appear, a bunch of people who have no wage change instead of a pay decrease. Practically all of economics is based on the idea of prices changing to bring the market back into equilibrium. That doesn’t happen with labor markets. That is a distortion.

Other possible market distortions include externalities, where the true costs of production or the total public benefit aren’t included in the market price.

It’s also impossible to prove that that we’re not brains in vats of goo.

That’s boring, I know, but what I’m trying to say here is that a person can dig in their heels on any given point, anything at all, and refuse to be moved by the available evidence. There’s always an excuse available to those looking for one.

What we’re left with is not proof in any absolute sense, but getting pushed to where the evidence takes us. And what we saw starting in 2008 and early 2009 was outright deflation combined with the biggest drop in total income since the 1930s, accompanied by the corresponding spike in unemployment. This was the situation when the Fed instituted its first bond buying program, already hard up against their lower-bound.

You can look at subsequent effects after QE2, Operation Twist, QE3, and even the recent announcement that they were delaying the taper contrary to market expectations. These data points build up. The ECB is unable to achieve its own 2% inflation target, and will likely pursue its own QE program very soon. It took them five years to reach their own lower bound, and unemployment is over 20% in places like Spain. It’s not proof. It’s never proof. But the evidence builds up.

More importantly, he maintained the interwar gold standard.

If wages are sticky, not allowing labor markets to clear, then we would expect any increase in real wages – for instance, during a time of deflation – to result in a corresponding loss of employment and production. We see a correlation of negative 0.94 between real wages and industrial production between 1929 and 1940. We see industrial production in almost perfection synchronization with every increase in the real wage, and then we see industrial production rising again as real wages fall after FDR dropped the gold peg.

My explanation could be wrong. Correlation isn’t causation. But if it’s wrong, then whatever new explanation that’s out there must necessarily include this amazingly robust relationship. Saying that Hoover fucked around a bit with markets in a coercive manner isn’t going to cut it. There’s no meat on them bones.

The historical record says that every nation in the world has abandoned commodity money, or any precious metal standard, to rely on a fiat system.

Every nation, without exception.

Sometimes they work. Sometimes they fail. When a fiat system fails, it’s replaced by a new fiat system. A peg is often used to stabilize a broken monetary system, but the peg is always to another fiat currency, or a basket of such currencies, not to any commodity. That is the historical trend, and it is indisputable. I’m not going to engage any more fiat digressions in this thread.

The following is on topic:

Right now I’d say the most likely result is that the Fed holds on to them until maturity, or close enough it doesn’t matter. As more and more mortgages get paid off, the Fed will receive that principal back.

You say “inflated” prices. You don’t give a standard for that. The housing market has stabilized. Holding the bond to maturity should give roughly what they’re paying for it. If they slowly unload, they shouldn’t lose much at all. Interest will slowly increase, which will slowly eat into the remaining value of the bonds. If they’re forced to sell quickly for whatever reason, then they’ll take a hit on their balance sheet based on the firesale. Their balance sheet will, technically, go into the red. This is actually pretty likely, all in all. The WSJ will write many breathless editorials, but ultimately devoid of content. Their liabilities are almost exclusively accounting liabilities only, with no additional legal obligations.

They started this with 800 billion of monetary base, and assets to match. Currency in circulation has since risen to 1.2 trillion. In other words, they could take a hit of more than a trillion dollars of losses without feeling it. They could take that loss, reverse all the QE they’ve done so far, and still maintain a healthy amount of monetary base in the system.

Who says the assets they’re buying right now are toxic?

The market stabilized. The already existing bonds have been paying predictably, or not paying predictably. They’re not terribly hard to price anymore. Their balance sheet will take a hit as interest rates go back up, and could easily go into the “red” in an accounting sense, but they’ll still have a good chunk of assets left. They could go into an accounting hole of over 1.2 trillion at this point and still be perfectly capable of pursuing a normal monetary policy.

Ron Paul’s idea of the Fed shredding some of its Treasury assets for the debt ceiling wasn’t the worst idea in the world. They could have done that one time. The problem was that there could be no encore performance. It wouldn’t keep working. For permanence, it needed a political solution.

By “fiscal options” you’re referring to increasing Federal deficits, yes?

Well, that seems like a poor summary of what I was saying, but if you want talk about Fed bond purchases, Fed bond purchases IS how the Fed sets interest rates. What they’re doing with QE is just continuing to purchase bonds long after rates have gone to effectively zero. What’s important to remember about QE is what the Fed is doing is buying assets from the public in exchange for cash. It’s not just dumping money into the economy willy-nilly.

On a different point, you’d said the “everyone” agrees the Fed has to unwind its position at some point. Not everyone agrees with that. Some would argue it can and should hold onto its assets indefinitely. And that to the extent that inflation becomes a problem, it should be fiscal policy, not monetary policy, that should be used to control it.

Essentially. (There may be a gray area between monetary and fiscal – wasn’t someone in the threads speaking of printing fiat money and dropping it out of helicopters? :eek: )

Note that deficit spending on capital investments don’t represent a current loss (for the same reason loans backed by home mortgages have a better status than loans to buy perishables).

The U.S. has decaying bridges with no one to repair them, and unemployed people capable of bridge repair. There is an easy way forward … or would be if the Cable TV natterers weren’t telling Americans that “all guvmint is de eevul.”

Maybe if the government included the asset value of say, roads, or mass transit, or schools, or police or social projects it would change people’s thinking. “Look, a functional justice system costs x to maintain, but its an an asset worth x+y, so we’re actually making a profit off the deal. (We’re better off than if we didn’t have it.)”

Or maybe not.