QE2 launched to much fanfare

This was no buy the rumor, sell the news week.  This week, it was buy the rumor, buy the news…whatever you do, just buy, buy, BUY!

The Federal Reserve will create dollars out of thin air and use them to buy debt issued by our Treasury Department, and this was good news to markets.  Everything, except the U.S. dollar, rallied. 

Happy days are here again.  A chicken in every pot, a car in every garage, prosperity for all.  Print away, dear Fed!

Okay, I’m just bitter because I thought  more than 3 people might see election outcomes, quantitative easing part 2, and 9.6% unemployment as less than good news.  I was wrong.

But, the little voice of reason in my head is screaming in protest, “How can printing money with no backing create prosperity?!  I know, for a fact, it can’t!!!” 

A lower dollar means a little extra business for a couple of U.S. exporters.  But, the U.S. imports vastly more than it exports, so it means higher costs for the majority of us. 

If you don’t believe me, look at commodity prices–they’re up 19% since August.  The rocketing price of cotton is jacking up clothing costs.  Oil at over $86 a barrel will translate into high gasoline and heating oil prices.  Copper closing in on $4 means higher prices for electronics.  Et cetera, et cetera, et cetera.

Soon, this will translate into higher costs and lower profits for U.S. companies.  It will also mean higher prices for all U.S. consumers.

Quantitative easing will not create jobs in the U.S. or increase lending to U.S. businesses (although both of those things are occurring completely separate from and despite federal action).  The Fed’s printed dollars are going to find their way into emerging markets, commodities and government bonds.  In the short run, it means “party on, Wayne”; in the long run, it means more inflation.

Oh, by the way, the last 2 times the Fed tried to create prosperity with the printing press (and the economy was not on the brink of financial collapse) ended in the dot-com crash and the housing crash. 

While the party is going, it will seem great, just like the NASDAQ and housing bubbles back in 1999 and 2006.  But, when it ends, and few will see it coming or be prepared, it’s going to hurt like no hangover we’ve ever experienced.

In the meantime, the markets will rally and the prudent will look foolish.  And, yes, I’m looking like a fool.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

QE2 launched to much fanfare

Unemployment puzzle

Unemployment in the U.S. has stayed at a stubbornly high 9.5%.  This has puzzled many economists, politicians, commentators and individuals.

In almost all post-WWII recessions, employment has recovered more quickly toward normal levels.  But not this time.  In fact, unemployment hasn’t stayed this stubbornly high since the Great Depression.

I think I understand why, and, if I’m right, it means unemployment will stay high for quite some time.  I believe there are two causes: interest rate policy and the unemployment safety net.

When the government sets interest rates, they will of necessity always be above or below where free-market rates would settle in the natural supply and demand for funds.  Just like any government price control, it will always and everywhere lead to either surplus or shortage

When rates are set too high, new investments won’t be made where demand would otherwise exist, leading to mis-allocation of capital and an economic slowdown.  When rates are set too low, new investments will be made where demand would otherwise not exist, once again mis-allocating capital, but with a boom and bust cycle ensuing.

Because the majority prefers lower interest rates and we live in a democracy, too low interest rates are most often what we experience.  That leads to an escalating over-investment and crash cycle.

Remember the dot-com boom?  Prior to that episode, the Federal Reserve had dropped interest rates to fight the Asian contagion, Russian default and Long Term Capital Management debacle of 1997-1998.  In 1999, rates were maintained at artificially low levels to deal with the phantom Y2K problem.  The result: a dramatic over-investment in technology, media and telecom that resulted in a tremendous mis-allocation of capital and employees.  To this day, fiber-optic cable that was deployed 10 years ago still hasn’t been fully utilized.  To this day, people who were employed in technology, media and telecom during the boom are transitioning into other fields.

To fight the dot-com wipe-out, the Fed again resorted to extra-low rates.  These low rates encouraged people to speculate again, but this time in the housing and credit markets.  The result, again, was a huge mis-allocation of capital.  Many more homes were built than people could afford.  Many more loans were made because home ownership was seen as an inherent good.  Many more cars were built and auto loans were made because rates were so low.  The result was a tremendous mis-allocation of dollars and people to the housing, financial and auto markets than otherwise would have existed.

Now, of course, many of those who had been employed in housing, finance and the auto field are unemployed.  The mis-allocation of capital to those fields has led millions to be trained to do something for which the market had no need. 

And, this is where the unemployment safety net comes in.  When those employed in technology, median and telecom lost their jobs, they had to find new ones.  Because they weren’t offered unemployment benefits for 99 months, they went and found new jobs.  Many of those jobs, ironically, were in the housing, finance and automotive fields that were being artificially spurred by too-low interest rates!

I’m not blaming unemployment insurance as a political statement.  I’m pointing to facts.

Rogoff and Reinhart’s work (This Time Is Different) shows how employment recovers much more quickly in emerging economies without unemployment benefits.  Whether a recession or banking crisis hits, emerging economies recover employment more quickly. 

Anecdotically, I’ve heard several stories of people who could get full- or part-time work, but elect not to because they’d be paid less to work than not to work!  It’s not a political statement to say that many people prefer to be paid not to work than to work. 

Combine huge mis-allocations of capital due to interest policy with a huge unemployment safety net, and you have a recipe for sustained, high unemployment.  (As another example: see Europe.)

Or, consider the Great Depression.  Interest rates were held artificially low after World War I to allow France and Britain to less onerously pay back war debts.  The result was first a huge real estate boom and bust in the mid 1920’s and then the stock market boom and bust in the late 1920’s and early 1930’s. 

Just like recently, artificially low interest rates led millions into fields that had no fundamental end demand (at that time, most of it was related to farming and banking).  When the inevitable bust came, millions were laid off from those fields and provided unemployment benefits. 

Interest rate policy leads to mis-allocations of capital and large groups being unemployed.  Unemployment safety nets then encourage those unemployed not to look for new work.  It’s a recipe for high and sustained unemployment every time.

If I’m right, we’ll have high and sustained unemployment until capital is correctly allocated (not likely with–once again–artificially low interest rates) and/or the unemployment safety net is removed, neither of which seem likely in the short or intermediate term. 

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Unemployment puzzle