Quantitative Easing Isn't The Devil

I'm growing increasingly irate at some of the descriptions of Quantitative Easing I've read in the blogosphere recently.  Meg Marco of Consumerist, a site I love and read daily (but let's not pretend that it isn't just another outrage blog), describes it as:

1) A bank has something they don't want to sell because nobody is paying enough.
2) The Fed is like, hey, how about we buy that off you for a little bit more than market price.
3) The bank is like, yeah cool.
4) The Fed credits the bank's account with money that it creates.

This is ostensibly correct, though it's missing some context I'll fill in below.  The tone of Meg's article is skeptical, and naturally it provides a nice venue for Consumerist's outrage brigade to vent about printing money = inflation in the comments.

This article from NPR explaining QE is just as vapid, summarizing it as "It means creating massive amounts of money out of thin air with the hope of getting the economy back on track."  Matt Taibbi does a pretty good job of comparing it to Zimbabwe's monetary policy while also taking his requisite shots at Wall Street fat cats.

Here's QE in my nutshell:  The government wants to encourage private lending to spur the economy.  One way to encourage lending is to lower the interest rate it charges banks to borrow money from the Fed, who in turn will borrow more money and then lend it out to private consumers, who presumably use it to open businesses and buy durable goods and etc.  Because that "discount" rate is already 0.75%, it can't reasonably go much lower.  Instead, what the Fed can do is make up imaginary money in a special account and buy up fixed assets from banks.  QE is targeted at particularly unsavory assets (think CMOs and other collateralized debt vehicles), and gives banks a ton of cashmoney, which they then will (in theory) lend out.  Unlike other similar programs, like TARP and Hoover's RFC, this isn't a budgeted expense.

Is it printing money to feed into the economy?  Technically yes.  Why isn't this a huge problem?

Because it's what the Fed does every single goddamn day.  The government tracks the difference between the target Fed funds rate (the interest rate banks charge each other for overnight lending to meet reserve requirements) and the actual Fed fund rate and conducts Open Market Operations to guide the actual rate towards the target.  It happens literally every day.  Sometimes the Fed makes up imaginary money to feed to banks to increase the money supply.  Other times (and this is important) they take that money back off the market by selling whatever security they originally purchased.  This is the minor daily mechanism for monitoring and adjusting interest rates, compared to the major big stick of the eight yearly meetings to discuss adjusting the discount and target Fed funds rates.

QE isn't a Zimbabwe-style money-printing inflation-causing apocalypse because after the Fed sends a few billion dollars to their favorite banks, they end up sitting on a massive pile of interest-bearing debt securities that 1) make money (unless the security collapses due to bankruptcy or foreclosures) and 2) will later be sold back to the market, when the investment climate is better, for close to the premium they paid in the first place.  In terms of the long term monetary supply it's essentially neutral.

In the short term, yes, it might cause a mild uptick in inflation (hence the article about TIPS Fever yesterday from the Times), but in five or six years when the Fed starts selling off its billions of dollars of holdings, it will suppress inflation.  It's not fundamentally different from how the government has been handling its monetary policy for decades.  It's not the end of the world.  There are times and places for uninformed outrage at government policy, but this isn't one of them.

I love this:

Jonah Goldberg, author of Liberal Fascism, gets uppity about some other blogger using the term "nihilism" to describe Mitch McConnell's political philosophy (which, in his own words, is that "The single most important thing we want to achieve is for President Obama to be a one-term president.” )

Yeah, NRO's The Corner, you go girl.  You tell fellow NRO bloggers Andy McCarthy (author of The Grand Jihad: How Islam and the Left Sabotage America) and Stanley Kurtz (author of Radical-in-Chief: Barack Obama and the Untold Story of American Socialism) that Jake Tapper is totally out of line throwing around aggrandized political and philosophical terms like that.

Head, meet Desk

Articles like this make me want to crater my own skull.  The following two opening paragraphs represent some of the most shamelessly ignorant financial reporting I've ever seen in my life.

At a time when savers complain that they are earning almost no interest from their bank accounts, some investors on Monday bought United States government bonds that effectively had a negative rate of return.

Bizarre as it sounds, that is correct. In an auction of a special kind of five-year Treasury bond, investors paid $105.50 for every $100 of bonds the government sold — agreeing to pay the government for the privilege of lending it money.

What the Times is nominally suggesting here is that investors are purposefully buying into 5-year securities that ultimately represent a loss of money at the conclusion of the 5 year term.  It's not ambiguous.  "Negative rate of return."  It's also retarded and/or deceptive.  It's Finance 101 retarded.  Here's what's really happening:

Fixed income products, such as bonds and Treasury notes, have a fixed coupon rate of return.  A 3% bond pays out 3% of its principal face value yearly, representing a 3% annual return.  Annual.  Got that?  Ok, so when you buy these notes, they're most commonly on a secondary market where other investors can bid the note up or down.  Appealing investments often sell at a premium above the face value of the note.  Unappealing investments sell at a discount.  This is normal.

NYT is citing notes being purchased at $105.50, which is a 5.5% premium.  We'll get into the reason for the premium later, just note that that buy-in premium is a one-time deal.  So you buy $100 worth of note at $105.50.  Let's say it's a 2.75% 5-year note.

Day 0: Paid 105.5, own 100:  5.5% loss
Year 1: Paid 105.5, own 100 note and $2.75 in interest (total 102.75):  2.75% loss
Year 2: Paid 105.5, own 100 note and $5.50 in interest (total 105.5): Even Steven.

YOU STILL HAVE THREE YEARS OF INTEREST COMING AT YOUR DUMB FUCKING FACE CHRISTINE HAUSER

You're not "agreeing to pay the government for the privilege of lending it money" because you're still coming out in the green at the end of the term.  You're only experiencing a negative return at the moment of purchase, a 1-time cost, which is totally mitigated (at current TIPS rates) in the middle of the third year.

The article also does a woefully inadequate job of explaining this "special" Treasury security and why it would be selling at a premium in the current economic climate.  Specifically it's about Inflation-Protected securities issued by the Treasury, or TIPS.  The principal value (the $100 in the previous example) is tied to the CPI inflation bundle and adjusted up yearly if there's been inflation, so your coupon rate (currently something like 2.375% for these 5-year TIPS) is fixed but is multiplied against an ever-increasing principal value, so your interest payments increase.  TIPS are a zero-risk hedge against anticipated inflation, whereas other traditional fixed income products have fixed rates AND fixed principal, so their value can deflate over time.  Currently most investors and analysts are predicting both increased interest rates and increased inflation (I'll try to link charts later, but go take a look at commodity pricing in 2010, specifically corn and wheat) which makes short term investments attractive (so that you can move into longer term stuff once rates go up) and TIPS attractive.  So obviously short-term TIPS are going to sell at a premium.

More Bubble

Just wanted to post a quick chart I ran across (thanks SF Fed) that neatly summarizes some of the domestic housing bubble issues and touches a bit on how that was affected by planned communities (and perhaps the New Urbanism trend in selected locations).  When you think about mass-construction planned communities, developments that have billboard advertisements and have phases and are sold as much as investments as homes, what areas of the county come to mind?   Florida, certainly.  Cheap land in the southwest.  The suburban areas surrounding DC and Baltimore in the mid-Atlantic.  Bad adjustable rate mortgages funded the majority of these new purchases, as demonstrated:

So there you go:  Florida, the southwest, the mid-Atlantic.  Michigan is a surprise to me, but I don't know much about that state outside of Detroit's economic issues (which, given their real estate prices, could theoretically account for the entirety of the principal-value delta statewide).

I am also stunned that Texas is in relatively good mortgage health.  I'd have figured it was in the same expansion and development boat as Arizona.

Steel & Glass

Every now and then you can discover a hidden message in the New York Times, if you have the background knowledge to read between the lines.  It's almost always a 1-2 combination of flat news-of-the-day story positioned next to a softer article about some local culturish thing affecting the subject of article 1.  Article 2 never directly states its intentions, but there's enough context between the lines to decode the message.

The top left article on nytimes.com right now details China's Central Bank declaring a not insignificant hike in their prime interest rates.  Since the global market crash in late 2008, it's been largely China's booming export and construction industry driving global growth, thanks partially to heavy government stimulus in the form of infrastructure and planned housing projects.  Chinese banks were also a main factor in their strong recovery, as they were much more liberal with their lending during the post-crash period, whereas American banks (the ones still in business) were more averse to lending (Matt Taibbi has a great article from a year ago about how American banks took TARP and other federal subsidy funds and, instead of lending as intended, bought treasury securities which were paying out a higher yield than the negligible interest rate they were paying at the discount window to borrow the money in the first place, effectively loaning the government back its own money and collecting a 2-3% spread.  I'll try to find and link it later.)  The rate hike is an effort to deflate inflation concerns, both specifically targeting the housing market and for their currency in general.

So China's booming economy and pegged currency exchange rate meant they were exporting like crazy and had more money than they knew what to do with, and banks were shoveling money out the door.  So they found something to spend the excess cash on: more construction projects.  Even today, new high speed rail plans are being contracted, and so many dams are being built on China's stretch of the Mekong river that Thailand, Cambodia, and Vietnam are asking for a ten year freeze on construction to find alternatives that won't completely annihilate the downstream fishing industry.

They also build cities.  Not developments; cities.  The second NYT article of interest details Ordos, a large but mostly poor city of 1.5 million that serviced the materials mining industry in the Mongolian highlands.  Specifically, the article is about the new 15-square-mile patch of nothingness that has been transformed into a modern metropolis of glass, steel, fresh pavement and heavy landscaping, as an emulation of Dubai and other shining jewels of architecture in the middle of otherwise hostile geography.  Offices and apartments and houses are being snatched up immediately after (or even before) construction at record prices, but they're being purchased as investments.

My mother would find this story familiar.  She got her first taste of mass-construction planned-community real estate in 2004 when she moved to Naples, FL.  She bought a condo during a construction phase for $120,000 and then sold it six months later for $180,000.  Then she bought another condo at 150k and sold it for 200k the next year.  This became a main source of income for her as she flipped condos left and right, each one basically identical to the last, in identical sculpted communities, increasing the asking price 20% each time.  She continued playing the insane Naples housing market until she was stuck in a half-finished development for over a year (towards the end of the bubble in 2007) and sold at 70% of the original asking price, when she moved into a new speculative retirement/golf community in the middle of nowhere in New Jersey.

So that new Ordos district is basically a ghost town; a city built for 300,000 has approximately 30,000 permanent residents, and the local economy seems driven by hotel revenues generated by Chinese government officials occasionally visiting the area.  The new property is owned but largely unused (like much of the Naples landscape after around 2006), and nobody wants to sell at a discount because they feel that real estate prices must and will rise.  Ladies and gentlement, I bring to you the Great Housing Bubble of China.

Of course, the Times can't print "China's period of rising interests rates to defer inflation and speculative housing prices is basically the same thing as our 2004-2008 bubble", but they can dedicate front page space to the plight of Ordos and let us draw our own conclusions.

Trouble on the horizon.

Alex's new favorite book is the instruction/campaign setting book for Vampire The Masquerade: Redemption.

&$%#*$@ Apples, how do they taste?!?!

I'm getting a perverse pleasure from sampling the dozen different varieties of apples offered by my local grocer.  It's not something I've ever indulged in before, so I don't know why I'm going out of my way to map my lunch plans around a daily apple, but there it is.

Today I had a massive breakfast so I decided to go with a dual-apple lunch in leiu of anything more substantial.  First was a New York Gala, which cost me 38 cents, and I consider myself overcharged by 39.  It's frankly the worst apple I've ever eaten.  There's virtually no sugar content, but also no acidity or bite.  It's also the softest apple I've ever experienced.  It's like if you took the apple mush residue from a commercial juice making facility and reconstituted it into apple form.  I originally had no idea why people would pay money for this variety of fruit, but then, recalling my near death experience trying to exit the parking lot on a monday (which is kind of a senior expedition day for the local retirement communities), it hit me:  If I was an infirm granny with aching or fake teeth and GI tract issues, this is basically the only apple I could eat.

The second, a New York Empire, tastes like a soft hybrid of a gala and a McIntosh (internet research suggests I was close:  McIntosh x Red Delicious).  It's not as tart as a McIntosh, slightly sweeter than the Gala, and almost as soft.  Which is to say I dislike it severely.

My favorite since I began experimenting is a Jazz apple, which I'm surprised to learn is a hybrid of a Gala (yuck) and a Braeburn (hard, tart, yum) and is relatively new to the global apple market.  I've been wanting to try a Temptation apple, but it's three times more expensive than the NY varieties I sampled this afternoon, and rudimentary Google searches are turning up decidedly NSFW results that have nothing to do with the firmness or flowing juices of edible produce.

Search Theory

There is an obvious and a more nuanced response to this morning's news that Peter Diamond, one of Obama's nominees to the Federal Reserve Board (who is presently being blocked by Senator Shelby), has won a share of the Nobel Prize for Economics for his work in Search Theory.  Let me dispatch with the obvious attack vector:  Shelby's hold on Diamond was because of a lack of experience, which interpreted through a modern Republicanese translator means he's an egghead professor with no experience running a factory or a bank or a drug-fueled wrestling entertainment corporation.  Given how well field-tested Wall Street executives have guided the economy in recent years, between the banks themselves or the mutliple vassals of Goldman Sachs who've occupied advisory and oversight positions in the Executive branch for the past fifteen years, I'm not sure this is a terrible indictment.  But so to have this nominee, derided for lack of experience for this economic position, end up winning a Nobel Prize is quite a large volume of egg on Richard Shelby's face.  (This will also reignite the whole "The Econmics prize isn't a real Nobel Prize!" fiasco from Krugman's award.)

The more detailed examination is even more damning for Shelby.  Giving the senator the maximum possible leeway, his position could be interpreted as expressing concern for Diamond's economic focus on the economics of information (and the subsequent application of that research by his two co-winners to labor markets) instead of macroeconomic monetary policy (an important field nowadays with round two of Quantitative Easing nearing).  On its face, this is a fair criticism, if we were to assume this was Shelby's argument, which is dubious.  The truth is, naturally, less black and white.

I run into a large number of fallacious economic arguments on the internet, most commonly from college students/graduates who've taken a 101/102 economics course and suddenly think they have all the answers to the financial crisis.  These people are also almost always arguing the conservative position, because 101 econ teaches you a warped framework to understand the basic concepts of the field.  300+ level coursework begins to unravel the faulty assumptions and shows you just how nuanced and complicated economics can be.  I'd equate it to grade school history classes teaching you all about how the Pilgrims and Indians partied on Thanksgiving, Columbus was just a brave explorer, and we fought the British over their tea policies; you don't really get around to the slavery, war, religion, and socioeconomic issues for another few years.  So econ 101 is basically:  All information is perfect, free markets are awesome and regulate themselves to perfection, and regulation is inefficient.

The intellectual fight over free markets has waged for decades and isn't germane to this post.  Professor Diamond's research involved what happens when the assumptions of perfect information break down.  In 101 terms it means what happens when consumers are shielded from the knowledge of production costs and competition (because 101 reduces everything to a supply-demand curve).  In a broader sense, it touches upon just about every major macro- and microeconomic field of study you can imagine.  The specific work generated by the Nobel trio investigated how difficulties in the actual act of finding a job can cause stagnant employment growth, even when there are ample vacancies waiting to be filled.  The basic models created by Diamond's work can also be ported to, say, the housing market (to explain sagging home sales despite the vast quantity of houses available).  Nominally this field is known as the economics of Search Costs.  "Cost" here is applied in the economic sense, where a negative externality creates inefficiency in a given market.

But so here we have an economist who specializes in Search Costs, which have multitudes of applications to today's employment condition (putting aside the other economic uses), in a political climate most poisonous to Democrats due to slacking employment figures despite a recovering economy.  This is the definition of the guy we'd want involved in government right now.  His body of work literally addresses the problems our employment figures face today.

But he's not the right guy for Richard Shelby of Alabama.

Pitchf/x

I think it's pretty interesting that TBS showed full pitchf/x tracking data for the first two days of baseball playoffs, but after Thursday's strike zone controversies, they're no longer showing it at all for friday's Phillies-Reds game.  I found it a very nice addition to the baseball broadcast, something to understand how umpires affect the game, but I guess MLB doesn't want that curtain pulled.