I’m not an economist, but the Fed’s recent decision to unleash (that, virtually print) more U.S. dollars into the world economy–termed qualitative easing 2, or QE2 for short– really caused me to fret. Now, the idea, as far as I understand it, is that we need more inflation in order to have an full economic recovery, with jobs for people, and easy credit to let the people buy the expensive homes, cars, vacations, and restaurant dinners they haven’t been buying. So we’re all in agreement that QE2 is supposed to cause inflation, and when things are expected to cost more in the future, people will buy now. There’s disagreement whether we currently have deflation, and that this is the cause of all our woes; or whether we already have inflation in commodities (like food and gasoline), even as our houses are worth less and wages are stagnant.
But I don’t think QE2 will make any difference, though it may well inflate the cost of commodities. I’ve experienced two gung-ho economic periods, and both of them were driven by speculation. The first was the dot.com boom. Having dutifully studied the general rules of stock investment, I puzzled and puzzled about how companies with virtually no income could grow in worth so quickly and spectacularly–until a friend who’d once been a day trader tipped me off that it was speculation, and engaging in this market was not for the long-term investor. While I never put my money into a dot.com, I did managed to pull plenty out of them–there was a cornucopia of demand for writers to create content for the web sites, and even more for anyone who took a few hours to learn then-still-rudimentary HTML. Oh, and all the free drinks I wanted, thanks to the many open bar parties every dot.com hosted for the sake of mindshare, and to poach HTML writers from one another.
More recently, there was the housing boom, during which anyone could “buy” a house, or borrow money on a house, no questions asked. Peter and I were pretty amazed when we were able to take out a line of credit on our house in order to start a new business, and the bank barely seemed to blink. It was even more shocking a few years later, when we were able to extend the credit without any trouble at all, despite our income being less than stellar at the moment (see start-up business). I swear, that time, they never even sent an assessor to even look at the house to make sure it was still intact! However, you can stay it helped the economy–thanks to that easy funding, Peter rented an office, hired staffers, bought new business equipment, and took more business trips.
Unfortunately, not everyone was as conscientious as Peter and I are about paying back the money which had just been handed to them blindly. One set of neighbors quickly stopped making payments on the house they’d bought at a record price (a price which helped us claim additional credit so easily.) It still helped the economy though, if not the bank. With the savings on 9 months of rent, they bought a new SUV and took a vacation to Puerto Rico. Next door, a family of renters found out their landlord had defaulted on the house they were in–but then, he had an extra $2500 a month, no expenses, to spend on whatever he wanted, including a few intial months of payment on more rental houses.
Thanks to happy happy lenderman the banks got burned, and they’re plenty twitchy as a result. You can give them infinity money now, but they still won’t loan it to anyone they’re not absolutely positively, completely sure will pay back every penny and who already has the net worth of the loan in other assets which could be seized in an emergency. In my opinion, I don’t object to this principle–after all, lenders ought to loan out money with the expectation of getting it back with interest. Stricter standards might have caused us to be turned down for an extension on our line of credit in 2007, which might have meant we’d have one less person on staff earlier and thus, slower progress; but we’d also have been able to avoid laying off an employee (and paying the state fine as a result) when they abruptly shut down the credit in 2008, and we’d have a bit less debt now.
Nonetheless, I was surprised to see how strict the bankers have become. Even when we bought our house, our current pay stubs (from the day jobs Peter and I each had), our credit, and enough money to put 20% down got us approved quickly. Now we’re seeing if we can refinance to take advantage of the low interest rates (also driven by the Fed), and the lenders want to see two years of tax returns, complete with financial details of our businesses, confirmation of how much money we have in the bank, the value of our retirement accounts, the value of our cars, a current evaluation of our house, and not to mention, good credit. At this point, I wouldn’t be surprised if they ask for statements of character from three religious leaders, and my willingness, on a scale of 1 to 10, to sell one of my kidneys should I be unable to pay my debts. To boot, as soon as QE2 went into effect on Friday, I was on the phone with a lender, who was himself surprised to see the rates had just jumped up, and he had an e-mail telling him they were about to take another jump up in 75 minutes. I think one of the ideas of QE2 was that banks would lower their lending rate, because they’d be jonesing to make more money on all that money. But actually banks are now more motivated to keep their money, rather than loan it out. No banker wants to be holding a 4.75% loan when inflation hits 11%.
The obvious result of this is that there will continue to be less lending, or at least lending at higher rates. This means less people applying for loans, and of those applying, less gettng a loan. If there aren’t a lot of people competing for houses, there’s no reason for the prices of houses to rise. The real estate boom funded a lot of jobs, from the most obvious, like real estate agents, to less obvious, like start-up employees. Beyond that, businesses would rather not hire anyone unless they absolutely need them right now, either. Planned inflation is the last thing you want when you’re bringing on a new employee. As prices rise, the employee is understandably going to want more money, and even they don’t, their benefits and perks will cost more. And due to other factors (not QE2), businesses still don’t know how much that employee is also going to cost in the form of additional paperwork and taxes. As we found out the hard way, laying off even one employee is costly in California–doing so more than doubled the unemployment insurance we have to pay to the state, and they will continue to collect at that rate until all the money the laid-off employee collected is paid off. It seems like an odd form of insurance–I’d much much rather have kept her on for quarter-time, and helped her find a new great job. She could have collected the money directly, without having to deal with a bureaucracy, and we wouldn’t be paying it off slowly, interminably, to a state agency, which we thought had already been collecting money for this.
There is one path to inflation, thanks to a deflated dollar. QE2 may raise the price of goods manufactured abroad–or not. More dollars theoretically means one dollar is worth less than it used to be; but then, so many currencies are pegged to the dollar, they simply set their virtual printing presses into overdrive themselves.
So if we do get inflation, we’ll get stagflation with continuing high unemployment and high interest rates. This led to price controls which led to shortages, another form of misery. If we don’t get inflation, it’ll be because the banks are scared to let it go because they think there’s not money to be made with that money, or they need it to further pay off the many defaults they financed. And that doesn’t move things forward either.
As I said, I’m not an economist. But I’ve seen booms, and I’ve read about bad busts, and given what I see going on with lending these days, I don’t think QE2 is a good thing at all.
The complete model is somewhat involved, but the whole thing with all the gory details is explained well here –