Tension Over Iran Continues to Escalate

Late last week the EU reached a preliminary agreement to impose an embargo on Iranian oil as part of an ongoing effort by Western nations to impose economic pressure on Tehran to prevent Iran’s uranium enrichment programs from progressing.  As the second largest importer of Iranian oil, the EU sanctions could cause serious damage to the Iranian economy which has already been adversely effected by the United State’s ban of dealing financially with Iran’s central bank.  Iran has been far from quiet in their response to the proposed sanctions, threatening their willingness to close the Strait of Hormuz, a strategic trade route through which 20% of all oil traded must pass through.

The tension over the Iranian situation is hardly contained to the United States and EU, however, as any disruption with the Strait of Hormuz could have serious implications for the global oil market, which could in turn deteriorate international economic recovery.  Also cause for concern is recent efforts by the United States to enlist Japan and China to assist in their economic pressure on Iran.  Efforts to gain the assistance of China especially in the embargo has been complicated by recent United States accusations about Chinese currency manipulation, as well as China’s historically self-interested policies in dealing with dubious international regimes.  The willingness of the Chinese to assist in the embargo against Iran could have serious implications on the program’s effectiveness, though U.S. accusations of yen deflation and China’s selfish past dealings with regimes such as in the Sudan, does not make their assistance look promising.

Another Measure of GDP?

Umair Haque of The Atlantic recently proposed a supplemental measure of economic well-being, a “national balance sheet” to go along with the “national income statement” that the GDP calculation represents.  While the GDP formula (Y= C+G+I+NX) incorporates consumption, government spending, investment and net exports, Haque suggests another measure following the formula of W= N+F+I+H+S+E+O.  This formula states that “real human welfare equals natural capital, plus financial capital, plus intellectual capital, plus human capital, plus social, emotional, and organizational capital.”  Though Haque’s prescribed metric seems rather ambiguous and difficult to quantify when viewed pragmatically, the components of his “real human welfare calculation” do offer an alternate way of viewing not only current domestic economic well-being and viability, but also the country’s ability to continue to grow in the future.

If United States leaders can focus not only on the short-term factors such as private sector production and investment which factor into our current GDP calculation, but also consider inputs such as human capital and intellectual capital when making policy and budgeting decisions, the country may be better equipped to succeed in the long-term.  By adopting policies targeted at improving science and math programs in primary and secondary education, for example, policy makers could inspire a new generation of scientists, engineers, and entrepreneurs, occupations necessary and desperately needed in the digital age.  While Haque’s formula may not inspire any major re-examinations of economic theory regarding a country’s relative economic strength, his metric does perhaps offer a different perspective when addressing domestic economic well-being, one which could ultimately improve both current and future economic conditions.

Congress’ Deficit-Cutting Committee Fails

Monday afternoon the Congressional deficit-cutting “supercommittee” capitulated, failing to reach a compromise or deal on how to explicitly deal with the country’s growing deficit.  Markets fell significantly on the news, and though parameters to automatically cut $1.2 trillion from the federal deficit remain in place, Congress’ continued failure to address this fundamental problem continues to frustrate and hamper the economic recovery.  While ratings services Moody’s and Standard & Poor’s reiterated that the committee’s failure would not result in another downgrade for U.S. debt, the continued inability of Congress to reconcile the country’s debt only adds to the general uncertainty that is dragging recovery efforts.  As the Federal Reserve considers the possibility of yet another round of quantitative easing, as was illustrated by the questionable success of QE2, they alone cannot inspire a recovery within the markets.  Global markets seem to be reaching a point where their ability to forecast economic outlook is the primary determinant in their investment and consumption decisions, as opposed to the long-term interest rates which the Federal Reserve continues to target.  What is certain is that moving forward, the United States faces serious questions regarding their ability to pay off the debt which has been used extensively in recovery efforts, and Congress’ fierce and increasingly polarized partisanship continues to critically damage the U.S. economic recovery.

Quantitative Easing, Pt. 2: A Brief Explanation of the Concept

What is Q.E. and why is it used?           

Though there are “no generally accepted definitions” for the nomenclature used to describe the Federal Reserve’s actions, be it “quantitative easing” or Bernanke’s preferred title of “credit easing,” the specific actions of QE1 and QE2 seem to indicate that the Fed’s programs of monetary expansion and asset-purchasing most closely resembles Japan’s definition of quantitative easing.  Quantitative easing in the contemporary sense “works through inflating asset prices, lowering prices, lowering the exchange rate and raising inflation expectations, and thus reducing real interest rates”.[1]  Historically, during such a time of economic uncertainty central banks would institute expansionary monetary policies, carried out through open market operations, to lower the yield on short-term interest rates and inject more money into the economy.  Commercial banks will often use the central bank as a source of additional liquidity when offering loans and the lower the short-term interest rate, the less it costs them to access these supplementary funds.  Yet this expansionary policy has a limit, as when these short-term interest rates fall to levels of near zero, a “liquidity trap” ensues, and these expansionary monetary policies are rendered largely ineffective.[2]

When this becomes the case, central banks are forced to adopt more “unconventional” monetary policies to further stimulate economic conditions.[3]  To do accomplish this, central banks can implement quantitative easing programs which attempt to reinvigorate economic conditions by expanding their balance sheet through the purchase of both public and private assets to further expand the money supply and lower long-term interest rates. These purchases will, in turn, inject liquidity into the economy by increasing the demand for these private and public assets, providing excess cash for private firms and lowering the yield offered on government debt.  By increasing the cash reserves of private firms and lowering the yield on long-term government debt, the central bank can hypothetically arouse an increase in both immediate consumption levels and spur a rise in investment by easing credit and lowering the cost of lending and borrowing amongst both firms and consumers.

Given quantitative easing’s use of electronic monetary creation and deficit spending, much of the criticism aimed at quantitative easing is based on the argument that with such a policy, “the planned asset purchases risk currency debasement and inflation”.[4]  Though some inflation is good for an economy, and quantitative easing can be a viable response to deflation within an economy, the scope of most quantitative easing policies risks severely devaluing the currency and putting excessive inflationary pressures on the economy.  Additionally, since much of the asset purchases of a quantitative easing program are composed of government debt, critics are wary of the effect such programs will have on the long-term prospects of a country based on the sizable increase in deficit spending quantitative easing programs employ.

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[1] Reddy, Sudeep. “Quantitative Easing: How It Works; When It Doesn’t.” Business News & Financial News. The Wall Street Journal, 4 Nov. 2010. Web. 5 Nov. 2011.

[2] Eggertsson, Gauti B. “”Liquidity Trap”" New York Federal Reserve. Web. 4 Nov. 2011.

[3] See Klyuev et al.

[4] Asness, Cliff, Michael Boskin, and Richard Bove. “Open Letter to Ben Bernanke.” Letter to Ben Bernanke. 15 Nov. 2010. Wall Street Journal. Web. 11 Nov. 2011.

Quantitative Easing in the United States: An Examination of its Historical, Contemporary and Future Uses Pt. I

Over the next few days, we will be posting a multiple part series examining quantitative easing in the United States, beginning with its historical beginnings all the way through the possibility and implications surrounding QE3.  The series begins below with an introduction of the topic:

Introduction:

In the early fall of 2007, the American economy was thriving, with housing prices, company profits and stock market indexes reaching historically high levels.  Though the dot com bubble crash of the early 2000’s had occurred less than a decade before, the booming economy had now pushed the Dow Jones Industrial Average to nearly twice its level at the bottom of the 2002 crash, peaking at nearly 14,200 on October 11, 2007.[1]  This elevated level of economic prosperity was short-lived, however, as the housing bubble which had fueled the economic rise soon crashed as subprime mortgages default rates began to soar.  The stock market began to fall, crashing a year later in October of 2008 and falling to just over 6,600 by March of 2009.[2]  The collapse of 2007 has left the global economy in a continued state of both economic depression and uncertainty.  The underlying causes of this meltdown are a combination of failures of both complex financial instruments and regulatory bodies, as well as a misrepresentation of overall institutional risk and overextended credit.  In their Levin-Coburn Report, the United States Senate concluded that “the crisis was not a natural disaster, but the result of high risk, complex financial products; undisclosed conflicts of interest; and the failure of regulators, the credit rating agencies, and the market itself to rein in the excesses of Wall Street”.[3]  The subsequent collapse of Lehman Brothers, a financial services firm which at the time of its bankruptcy held $613 billion worth of debt, further exacerbated the problem and sent shockwaves through the already fragile global economy.[4]  In response, governments across the world adopted a variety of fiscal and monetary policies to try and limit the damage and reinvigorate the international marketplace.  In the United States, Congress implemented fiscal policies such as the American Recovery and Reinvestment Act of 2009 to lower unemployment that plagued the economy through a series of “shovel ready” projects, similar to those of the New Deal during the Great Depression.[5]  Simultaneously, the Federal Reserve began a series of unconventional monetary policies to try and inject liquidity into the marketplace.  These policies, inspired largely by the Bank of Japan’s actions in the early 2000’s, were a series of “quantitative easing” measures designed to jumpstart economic lending and investment.

To date, the Fed has implemented two major quantitative easing programs, commonly referred to as “QE1” and QE2,” as vehicles for this recovery.  While these programs have “contributed to the reduction in systemic tail risks following the bankruptcy of Lehman Brothers,” the overall success of their implementation remains ambiguous as “financial conditions remain tight” and bank lending channels remain “strained”.[6]  As the economic recovery remains slow and dragging, speeches by leading Fed officials seem to indicate another round of quantitative easing, or “QE3,” may be on the way.  Amongst leading economists, the relative success of such a program remains uncertain and contentious, with critics pointing that the country may be “reaching a point of ‘diminishing returns’ with its asset-purchasing programs”.[7]  Given the lack of definitive empirical evidence to support either side’s claims, as well as the exceedingly polarized political environment within the county, it appears that a program such as QE3 will do little more than increase the uncertainty within the markets that continues to hamper lending and investment level, making such a program ultimately ill-advised.

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[1] “Google Finance: Dow Jones Industrial Average.” Google. Web. 9 Nov. 2011.

[2] See DJIA.

[3] Levin, Carl, and Tom Coburn. “Wall Street and the Financial Crisis: Anatomy of a Financial Collapse.” United States Senate. 13 Apr. 2011. Web. 3 Nov. 2011.

[4] Mamudi, Sam. “Lehman Folds with Record $613 Billion Debt – MarketWatch.” MarketWatch. 15 Sept. 2008. Web. 6 Nov. 2011.

[5] Press Release. “The Recovery Act.” Recovery.gov – Tracking the Money. 17 Feb. 2009. Web. 9 Nov. 2011.

[6] Klyuev, Vladimir, Phil De Imus, and Krishna Srinivasan. “Unconventional Choices for Unconventional Times: Credit and Quantitative Easing in Advanced Economies.” IMF. International Monetary Fund, 4 Nov. 2009. Web. 7 Nov. 2011.

[7] Washington, Jason Lange. “Federal Reserve Might Not Undertake QE3, And It Might Not Help If They Do.” Breaking News and Opinion on The Huffington Post. The Huffington Post, 13 Aug. 2011. Web. 9 Nov. 2011.

WSJ Survey Yields Intriguing CEO Advice

WSJ contributor Alan Murray recently surveyed a group of many of the top CEOs in business today, a group called the CEO Council, on what they believed was most needed to achieve a successful, global growth agenda.  As Murray notes, many of the responses he received were hardly revolutionary, such as calls for lower corporate taxes.  Yet while some of the respondents may have remained rather vanilla and generic in their input, others ventured out and proposed both intriguing and creative means of reconciling many of the problems we face as a global economy.  Bob Greifeld, CEO of Nasdaq, emphasized the need for immigration reform with an explicit goal of making it easier for the best workers abroad to come and live within the U.S. stating, “to be the best, U.S. companies need the ability to recruit the best workers. Global competition means global access to human capital. NASDAQ supports comprehensive highly skilled immigration reform. We must increase the number of H-1B visas available and reform the employment-based green card process.”

Along with Mr. Greifeld’s take, others encouraged a more privatized approach to U.S. infrastructure, a refocus of developing students interested and strong in math and science, as well as a simplification of the increasingly complex tax code.  Another particularly intriguing response ties back to yesterday’s discussion on the implications of the complexities and uncertainties of the Dodd-Frank implementation.  Steve MacMillan of Stryker states to move forward competitively, we need “balanced, reduced regulation. The pendulum has simply shifted too far, and many of our most innovative industries—health care, energy and finance—are all currently stymied by the amount of new regulations, further enhancing uncertainty and adding complexity.”  A few echoed his point, a fact which once again suggests that while regulation is certainly a necessary part of the current global economy, a lack of transparency in its methods and means of attaining its goals tends to only heighten uncertainty within its designated industry, a severe detriment to an already fragile economic state.

What the Egypt revolution means to the U.S.

USA Today ran a great article today on what the revolution and ousting of former President Mubarak, who had been in office for the last five U.S. Presidents, means in terms of U.S. foreign policy within the region.  Mubarak’s alliance with the United States had done a great deal in counter-terrorism efforts, especially regarding Hamas, who now controls the Gaza Strip.  Without him in power, the White House must reach out to whoever comes into power in Egypt to re-establish U.S.-Egyptian relations.  Exactly who America will be reaching out to may also be a troublesome manner, however, as Mubarak’s banning of the Muslim Brotherhood helped to constrain the power of a group which preaches conservative Muslim ideas and anti-Western sentiment.  With democratic elections it is very possible that this group, which inspired Osama bin Laden and assassinated former Egyptian president Anwar El Sadat, may be in control of Egypt.  This, along with the potential for a spread in uprisings within the Middle Eastern region, makes the conflict extremely sensitive.  A rise in the Muslim Brotherhood would certainly spell an increase in anti-American spirit and threaten our ally, Israel.  While no time frame for the elections have been established, the U.S. must actively monitor the events in Egypt especially carefully as regional stability and Israeli safety is a very real concern.