Wednesday, 11 August 2010

The strange world of "quantum" money

On 21st Dec 2008, I predicted that the Fed would find it very difficult to reverse its monetary expansion once it had repaired the many punctures of the previous asset bubble. Yesterday's announcement by the Fed partly vindicates my fears but it appears the Fed believes those punctures are not fully repaired. Extraordinary loose monetary policy continues to be the order of the day. Whether this will, as Mr Buffet fears, and as I suggested 18 months ago, result in runaway inflation, only time will tell. My suspicion is high unemployment will delay that eventuality but the Fed will delay a reversal of loose money for even longer.

Inflation aside, there is a bigger problem with the loose monetary policy pursued by many of the world's central banks. Particularly those that seem to have redefined the meaning of "persistent" as has Mr King on behalf of the BOE. There seems to be a somewhat tautological feat being performed by these central banks in keeping monetary policy extraordinary loose as a means for reversing the pain caused by monetary policy which was loose prior to the crash. I suspect monetarism behaves in an unpredictable and non-linear manner when the cost of money reaches levels below classical dimensions as they have today. Just at with physics, some "quantum" effects must come into play which makes loose money not nearly as effective as Mr Bernanke and Mr King seem to believe. One such quantum effect is the behaviour of the consumer as suggested by classical economics. Monetary policy seems to predict that there is a clear trade-off between savings and consumption and that consumption is favoured over savings when interest rates are low. This may not necessarily be the case when the cost of money is hovering just above 0. Ultra-low rates may actually cause the perverse outcome of reducing consumption and increasing savings. This can occur when you consider the vast majority of savers still rely on short term interest rates to provide supplementary income through bank deposits and money markets. When rates are this low they may have to save more to offset the decline in rates. In addition at very low rates, loan spreads to deposits also tend to increase, and banks make hay, thereby compounding the pain to your typical saver who also has liabilities such as mortgages. The "quantum" behaviour of money therefore may actually cause much greater unpredictability in consumer behaviour and help to promote perversely a much a longer period of deflation. Quite the opposite of what central banks are seeking to achieve. How else do you explain the combination of near zero rates in Japan and the lost two decades?

The massive distortion of price of risk assets by the central banks also supports the very wealthy who own the majority of financial assets and also have the ability to invest through far more sophisticated tools than bank deposits. Arguably they have much bigger saving buffers in any case.

Time for central banks to rethink monetary policy and return to more normal interest rates?


  1. Increasing Interest rates also sends a signal that the economy is recovering, if people believe that then it becomes a self-fulfilling upwards spiral as opposed to the Doom mongering depressionists creating a downward spire as people believe the fear and restrict their spending.

  2. Rates will affect spending habits during a healthy economic period but people are no longer basing their habits on rates, they are now basing them around job security factors. The policy makers don't seem to understand this common switch. Neither did the Japanese government and by keeping rates low they ensured that this fear prevailed. America and Europe seem hell-bent on making the same mistakes.

  3. It is the economic uncertainty going forward that is causing consumers to re-think their spending and saving habits. Oddly enough, even with historically low interest rates, the consumer driven economy is treading water. Americans are concerned whether they will have a job tomorrow to pay the mortgage and put food on the table. There is a leadership vacuum when it comes to truthfully making the case for an improving economy ahead. Bernanke tells us absolutely nothing each month other than the same tired mantra of "rates will remain low for an extended period". That statement by him does absolutely nothing to instill the vast majority of Americans' confidence in the economy. President Obama tells us that the recovery will be slow and to expect unemployment to stay high for the time being. Other, so called economists, tell us that the economy has bottomed-out, and we are on an upswing, while others preach deflation is upon us, and still other pundits point to the price of gold and tell us hyperinflation is just around the corner. Can you blame us for squirreling away what money we can, even in savings accounts paying almost nothing in interest? Oh yeah, what about the stock market, which has risen 60 percent from the bottom in March 2009? Well, look who is in the markets. It's not your average John and Jane Doe anymore. They have no confidence in that casino that cost them their nest eggs. So, just hand me another coffee can so I can dump my change in it. Hopefully, I'll have enough to retire in a couple of hundred years.