September 15, 2013 8:30 pm
Quantitative easing: Tale of the taper
By Robin Harding
The FT tells us that the taper is close, if not already here, detailing
‘ strong reasons to expect a tapering of asset purchases this month’
FT goes on:
‘Compared with last autumn, the path back to maximum output – which the Fed puts at a 5.6 per cent unemployment rate – looks much clearer. Even if QE3 gets a reprieve in September its time is nearly up’.
FT goes on to explain that beginning the taper now will not even really affect the final scope and effect of QE3 that much. Tapering now:
‘will make a marginal difference of $50bn-$100bn in the total assets that the Fed will acquire by the end of its programme. The Fed thinks that cumulative total is what sets monetary policy’.
So its how much you end up buying; not when you buy it that makes the real difference.
‘the symbolic effect is huge. A taper would signal the passing of “peak QE” in the world’s largest economy’.
And FT has come not to praise QE, but to bury it:
‘There is no way to know what would have happened without QE3. It did not transform a weak economic recovery into a strong one – growth has remained locked on a path around 2 per cent and the downward trend in the unemployment rate was in place before the policy started ‘
‘What QE3 does seem to have done is reveal the limits of using asset purchases as a tool to stimulate the economy. ..Growing worries about financial stability risks from QE3 have contributed to the move towards tapering.’
So FT is not sad to see QE go but it is worried that tapering is linked in the public mind to a rise, first in long term and then short term interest rates and this is definitely not something they look forward to:
‘As far as most Fed officials are concerned, any decision to taper asset purchases would have nothing to do with the timing of rate rises, which they do not expect to be justified until the economy is much closer to full employment.’
In fact, even some theoretical point of full employment might not be the time for the Fed to stop directly controlling the economy:
‘ if the damage from the financial crisis…..could persist for another five years or more. That would mean a slow rise in interest rates back to their long-run level as the economy heals’
So FT thinks that:
‘Interest rates will need to stay low for some time. The Fed and Ben Bernanke, its departing chairman, have to find a way to send this signal on rates even as they start to wind asset purchases down’
Which brings us to the nub of the problem: the credibility of the Fed in making the markets believe that interest rates are staying low for the foreseeable future, irrespective of the tapering of QE. In other words, if the Fed does not actually do anything (e.g. buy government paper), by what mechanism can it effect what the market does? If the Fed stops buying government debt, if home grown buyers for government debt cannot be found outside of the Fed, and if international buyers such as Japan and China are demonstrably less enthusiastic for government paper, how is this supposed to work?
Apparently the idea seems to be that the Fed will keep saying interest rates will stay low and this will magic that state of affairs into existence. This is not quite as bizarre as it seems at first glance. The Fed will argue that it has a direct line to the public via its authority and access to media. It argues that this means it can influence the public directly, effectively bypassing the markets. As this is the case the public will act as though low interest rates are assured and spend and borrow accordingly. So in effect the Fed is pitting the public against the markets and is betting that the markets will back down and go along- or that is the plan at least. Thus the FT asserts:
‘Markets may pay no attention – but the Fed has a loud voice and it tends to repeat itself until the message gets across.’
So it all seems to come down to the credibility of the Fed, which means the continuity of policy in the Fed over the next couple of years or so. And there is due to be a change at the top as Ben Bernanke leaves.
‘…uncertainty about who will be chair – and this person’s commitment to current policy – is likely to make forward guidance less effective, highlighting the urgency of a nomination by President Barack Obama and a prompt Senate confirmation.’
It seems that it all boils down to a question of personalities- Who is at the top and whether that person has got the personality to convince the world that low interest rates are here to stay based on- well, based on nothing really!
Well now, are you buying this?
The first thing I would point out is the argument that it is the total amount of QE and not the rate of purchase that matters. In other words the Fed has got as it’s overall target an amount to spend, in other words a proportion of something. A proportion of what? And how is this proportion calculated?
The second thing is the insistence that interest rates need to be kept down irrespective of the amount of QE being done. On the face of it, low interest rates and tapering seem like contradictory aims, after all the FT itself draws an explicit link (at least in the minds of the markets), between QE and interest rates- if the priority is to keep interest rates low, surely keeping QE going is the safest bet for making sure this happens.
Which leads us to where Crackernomics argues that the taper can’t happen and the game can’t stop- that Bernanke embarked upon an open ended game that can only end in collapse, but that’s because Crackernomics doesn’t understand what the game is.
So first question to be answered is: What is the total amount of QE to be spent and what does it represent?
The total amount of QE to be spent is a proportion of the total amount of democratised money that has been called into existence. In other words the Fed is effectively devaluing state currency until it reaches a level of parity with privately issued democratised money.
What is this level of parity?
It is the level at which it is generally accepted that the Fed can and will prevent any serious harm befalling any holder of democratised money. In other words no bank will go bankrupt as a result solely of holding mortgage backed NGM (Non-Governmental Money). The Fed is looking to establish an exchange rate between state issued currency and NGM.
Which leads us to the question: What will this exchange rate be?
At the moment it effectively stands at one to one but I think this is going to change.
I think the Fed is going to play the split- it is going to use the two halves of the QE program tactically.
First, the Fed will explicitly differentiate between purchasing government paper and purchasing democratised money.
Second, it will announce the purchasing of democratised money at a reduced rate, and indicate that this rate is subject to change, effectively creating a moving exchange rate between these derivatives and state currency. So the Fed will break the link between the amount of NGM it purchases and what it pays for it!
The Fed will then say that this is now different from purchasing government money. The Fed will then outline a program for continuing to purchase government paper.
So the Fed is going to:
Break the link between buying government paper and democratised paper.
Break the link between the amount of democratised paper it buys and the price it pays for it.
Continue to buy Government debt.