In Praise of Quantitative Easing!

Is quantitative easing the right solution to the problems presently plaguing US and Europe? Are the central banks recreating the loose monetary policies that in part led to the crisis in the first place? What role does monetary policy play in economic growth anyway? Is there a lesson we should learn in India from this?

Before I attempt answering these questions, I must briefly state a story I had read long back about a village where a general sense of gloom is pervading everyone and there is general despondency and pessimism among the villagers. The farmers, the bakers, the wood-cutter and all the rest of them go about their daily work with reluctance and eke out a rather modest living - always wishing they could have more.
One fine day a gentleman from a far off place visits the village goldsmith and tells him that he would like a very beautiful necklace made - for a rather princely sum. The goldsmith agrees and tells the fellow that he can make this masterpiece in a couple of months. The gentleman agrees to return after two months. The goldsmith is rather amazed at his fortune and decides to celebrate by finally ordering that new cart he had been dreaming about all this while. Thus he in turn visits the cart-maker and places an order for the cart. The cart-maker is in turn becomes quite happy with the turn of events and suggests to his wife that they put their presumably bright daughter for private tuition with the maths teacher. The maths teacher decides to stock more grain for her son's wedding and the farmer in turn..... and so on. In the next couple of months, the village is abuzz with a lot of activity and everyone seems to be happier - and most notably, better off!
Unfortunately the gentleman who ordered the necklace perishes in a ghastly accident (the original story did not mention the ghastly accident, I have added it for appealing to the sensationalist within us!!). He thus is not able to collect the necklace nor pay for it. As it turns out though, the village is now quite well-off even without this dosage of income. The goldsmith has other orders to attend and so does everyone.

The above story is an oversimplification but it does carry a very important and powerful message. As much as the economic activity is a function of size and productivity of various resources (capital, labour, land and entrepreneurship) in an economy, in shorter terms, it depends in large measures upon the confidence of various market participants. This can work to everyone's detriment (as it did in the village of earlier) or benefit (as in the village later on). Unlike other market determined inputs, this factor is largely psychological and built on expectations, fears, aspirations and such fuzzy stuff. Hence as much as the purists may hate to bring about subjectivity in their analysis, an economy (especially in turbulence) cannot be properly assessed without these factors.

This is partly what the central banks in the developed world are trying to do. The great depression was in part owing to genuine economic slowdown but was significantly exacerbated due to spiraling effect of the vicious cycle of lower confidence, lower investments, more employment, lower consumption and further lowering of confidence. Ultra-loose monetary policies and massive fiscal stimuli (never thought I would use plural of stimulus in economics!!) of today in the advanced economies are intended to break this vicious circle. In fact the biggest mistake of the then administration during the great depression was a premature belt-tightening by the government - which further depressed economic activity. Japan followed a similar course through its lost decade when it tried to maintain low fiscal deficits in the face of falling economic growth. Unfortunately the political deadlock in the US may force a similar move there as well - though the first dose of fiscal stimulus and still persisting loose monetary policies seem to have successfully averted a depression.

Whats the downside to quantitative easing? To answer that we should revisit the nature of paper currencies and what happens when a central bank prints money recklessly. One can read up on hyperinflation - Poland, Brazil, Zimbabwe all suffered from it in recent decades. Then how is it that US is not seeing any of this?

The answer lies in size and status. All the countries that suffered hyperinflation were trying to print money when the market for their bonds was non-existent (at least outside the home country). There is no use printing money if nobody is going to value it. Another vicious circle can strike such economies when outsiders refuse to convert the currency at any rate and eventually the country simply loses access to outside world - financially speaking. That is clearly not likely to happen to US or the Eurozone. In terms of status, the US occupies a special position as the country that issues the Dollar. That gives it far more leeway in printing more money than a Poland or Brazil.

In summary hence, quantitative easing and loose monetary policy have probably already served their purpose of averting depression. They seemed to have had only partial success though in pump-priming the economies into action through easy credit. That is when the central banking alchemy runs into the genuine problems of indebtedness of the average household and a true lack of the ability to consume as much as they used to till 2007! 

Stumbling on Happiness - review; and Next Steps

I recently finished reading the book "Stumbling on Happiness" by Daniel Gilbert (psychology prof in Harvard). The title is a little misleading - in that it sounds like a self-help book. In a way it is - but for the very scientific and left-brain sort of reader. In that sense, it might put off a lot of intelligent reader. I thought ten times before buying it myself (but then read a couple of pages to make sure).

The book makes two starting points
1. We feel happy about thinking about the future and controlling our path to future

2. Our happiness is independent of the destination we reach

Of this the first is assumed to be an agreed on hypothesis. The second is explained through the book. The idea is that we don’t know what makes us happy. However we continue to believe that we do. The first of this – that we don’t know what makes us happy is due to the following
1. The limitations of imagination – filling in details in our picture of the future, without us consciously knowing it; and more importantly leaving out details without us consciously knowing it
2. The tendency of human mind to construct the view of the future in the light of the present.
3. The ignorance of human mind of its own strength to rationalize – which makes a person suffer less than expected due to a negative event

The author then goes on to claim with supporting evidence from experiments that human beings are very unlikely to learn from their own experience – since memory is a very unreliable guide to how one “felt” in each event.

The final recommendation from the author’s side then is to rely on the experience of others who are currently in the state that we are expecting to be in future. Adequate explanation is given to deal with the claims of uniqueness of human experience (we are not really that different from each other).

There is a small excursion into why we continue to believe in the eternal truths of more wealth being better and children being a source of joy. This is quite important. The theory of super-replicators in the domain of ideas/beliefs is the same as that of suitable genes in the domain of biological evolution. The simple idea is that false beliefs can last long and grow in societies since these make those societies as a whole stable, prosperous and long lasting. At the individual level though, these beliefs may not be (and often are not) happiness-maximizing.

Next steps?!

In the context of my project of “The Handbook of Happiness”, where does this leave us? A few random lines of thoughts emerge as below
1. Planned happiness seems like an oxymoron after all. A linear program to “get” to happiness is oversimplification and delusive
2. There is one area covered in the book about human beings being prone to inaction rather than action – while still subsequently regretting inaction rather than action. This might then be translated into a bias to action (a la “Yes-Man” the movie) which also ties in well with the chaos view (not a part of this book) of life – one needs to expose oneself to a lot of experiences, some of which might make one happy after all.
3. Can we pre-empt our tendencies mentioned above? Or are they given? If we can pre-empt these, we can get a decent handle on our expectations of future happiness (or the lack thereof)
4. Can we optimize our pursuit of money and its uses such that the happiness is maximized?
5. The book still does not talk about chronic happiness – call it contentedness or state of bliss or so on. It is mostly about happiness from an activity limited in space and time. How does one translate that into planning a career or place of stay and other such long term decisions?
6. Is there not a separate line of enquiry into avoiding the traps of where we spend our energies? i.e. we do not actually always pursue happiness. Every now and then we are caught up in firefighting, dealing with jealousy, politics and so on. For some, these become protracted pursuits – often overshadowing the pursuit of happiness. These traps may also be self-perpetrating and hence difficult to get out of. It might sound too simplistic – but can one do a energy-spent audit every so often and thus find out if one is really consciously choosing to spend energy on some pursuits or it is happening through inertia (of motion in this case as against rest).

I have a bit of a confession to make here: every time I take up the thought of studying this in some detail, I come up against the following “retorts” from myself
- this is pointless; one can’t really plan such effervescent thing as happiness.
- this is all for well-off people with enough food, shelter and freedom, what about the large multitude of human beings which struggles to make ends meet?

However, I must reply to myself regarding the first above that while a grand program to be forever happy is a delusion, thought-through handling of the subject is not. It’s a bit like practicing for a race even when one has the talent/strength. One can’t produce a winner through practice alone but given everything else similar, the one that practices with more plan and thought has higher chance of winning. Hence while someone else may be happier without going through all the thinking through; the process of thinking constructively about better organizing our lives to orient them towards happiness can’t possibly harm us.
As regards the second point, it is really driven by the need to be politically correct (in my own eyes). While one should seek to make the poorer lot better, that is no reason one should not actively think about how to better organize well-provided-for lives for making them happier. It is almost like creating two different “offerings” for two different socio-economic classes. As long as this does not make the poor poorer still, it is harmless from their point of view. In fact, a few decades hence when the poor are middle class they might look up to the higher-ups in the socio-economic ladder for ideas on how to best use their new-found economic freedom!

Onwards then!!!

Modern Global Economy - Wither currencies?

Very few realize the depth of the changes Nixon brought about in 1971 when he depegged dollar from gold thus creating the modern currency markets as we know them. One of the most profound change was the paperization of currencies. This one move made all currencies into paper currencies - delinking them from any hard/real asset and thus allowing central banks everywhere to choose to print money at will!
In theory this was a good thing. (and no, I am far from an enthusiast of gold standard, this is not about that anyway). This allowed countries much higher degree of flexibility in managing their fiscal, monetary and economic  policies. In practice though, the world very quickly witnesses several cases of hyperinflation including Poland, Russia, Zimbabwe, Brazil and so on. Part of this was because the central banks of these countries sort of ignored the linkage of inflation with printing money (and thus money supply).

Till date though, it was thought that the currency systems after the abovementioned demise of Bretton-Woods-II was largely a positive thing - especially for the governments whose central banks were more responsible about printing money. The recent fall-out of the 2008 crisis however raises serious doubts about this.

There are three major contributions of the present currency system to the development, deepening and furtherance of the crisis.
1. Status of Dollar as a global currency - despite the freedom that the US central bank has in printing money
2. Manipulation of Yuan by China and their respective currencies by the East Asian governments to promote exports at the cost of domestic demand - thus creating long lasting global economic imbalances
3. Emergence of Euro - a monetary union which works in good times but complicates life significantly during bad ones.

I have detailed the first two in my book. The funny thing about the present currency system is that the fiscal and monetary policy independence enjoyed by individual countries is not entirely reflected in the interlinkages of their respective currencies with each other. The presence of central banks of all the leading governments - as active players in bond and currency markets globally - makes the matters even more complex. These are no more simply rational economic agents trying to maximize their risk adjusted returns - their behavior is far more complex and hence lends itself to rounds of second, third and higher order guessing by other market participants! (Imagine the recent anticipation ahead of Ben Bernanke's address at Jackson Hole!)

For a moment if we were allowed the "flight of rationalistic fancy", what would we wish for as regards global monetary system?

Tough question. I would think of a global currency backed by reserves held by all major economies with a central authority - in the form of guarantees or claims on hard assets. This currency to have tooth will also need some compulsory use in global trade - almost like a quote each country has to finish before starting to use any other currency for trade. This is half-return to gold standard. Half in the sense that there is no gold backing any one currency. However, the relative values of different currencies are not entirely in the hands of the respective central banks! That might solve the problem of uncoordinated monetary policy pushing the world into worse state every day. This needs more work!