John Hussman emailed me this morning regarding his latest piece. He clarifies that he does in fact believe QE is “funding” the deficit and creates a substantial risk of inflation in the future. He added a paragraph to the piece that clarifies:
“Let me be clear – the additional monetary base created by the Fed certainly is “liquidity” from the standpoint of the banking system, and does amount to funding the U.S. deficit by printing money, until and unless the transactions are reversed. As I’ve noted previously, at what is approaching 16 cents of base money per dollar of GDP, there will also be significant inflationary risk in the event of even modest upward pressure on short term interest rates. The point, however, is that it is incoherent to say that this “cash on the sidelines” will somehow find a home in some other financial market, or anywhere else in a manner that makes it vanish from “the sidelines” – until it is explicitly retired by the Fed.”
First, let me apologize to Mr. Hussman as it is clear that I took his words out of context. That was not my intention. On the other hand, I have to say that I believe Mr. Hussman’s thinking is incorrect. As I’ve explained before, QE does not add net new financial assets to the private sector. It is merely an asset swap. The banks that owned USTs swap them for reserves. The Fed gets USTs, the banks get reserves. There is no change in net financial assets. There isn’t more liquidity “sloshing” around as Mr. Hussman states. The banks already had the liquidity before QE ever occurred. This doesn’t mean banks can’t go out and do irrational things – after all, we wouldn’t have the terms “Greenspan Put” or “Bernanke Put” if Fed policy didn’t alter investor behavior….If you want to say that there is more liquidity due to deficit spending then that is quite a different argument and has nothing to do with QE.
Mr. Hussman says the Fed is helping to fund the government’s spending. I clearly disagree as the USA’s ability to spend money is never constrained by bond sales. He is, in essence, making the monetization argument. I won’t rehash that argument again, but this argument implies that the government, which is a money supplier of the currency that it alone produces, might run out of the ability to spend this currency. This is exactly like arguing that an alchemist can run out of his ability to make gold bars. This is essentially saying that the deficit spending could not have occurred without the Fed’s intervention.
The only problem with this argument is that there is no constraint in the USA’s ability to make USDs. The Fed’s role in the money creation process is to attempt to alter the degree to which banks leverage this government money. This should not be conflated with the Treasury’s role in spending money – which can only come BEFORE any bond purchases or taxes are paid….It can be no other way.