By Payam Sharifi
The author is currently pursuing his Ph.D. in Economics and Public Administration at the University of Missouri – Kansas City
One of the most common observations I make as I frequent the comments section of MMT blogs are the arguments in objection to it. When one mentions “keystrokes”, these posters immediately think of Weimar Germany and machines printing money and throwing them out into the streets (via helicopter or otherwise). After these commentators understand (through the help of other posters) that MMT notes that inflation is the only possible constraint to the issuer of a sovereign currency, they typically have their “gotcha” moment. Quantitative Easing (QE), they note, has been responsible for higher commodity prices and hence, MMT’ers are a bunch of crazy fanatics who want to turn the nation and the world into Weimar (or Zimbabwe). The even larger implication is that enacting goals for the public purpose is not something the government should be involved with. The view that QE is responsible for higher commodity prices is not entirely without merit, but not for reasons typically ascribed to it. By understanding the institutional aspects that MMT describes, one will understand not only the real transmission mechanism but also some other problems and solutions associated with higher energy prices. This post makes an outline of these issues.
Quantitative easing is essentially an asset swap between the Federal Reserve and its member banks. The idea behind QE is to bring down the long end of the yield curve (that is, to bring down long term interest rates) that cannot be targeted in the traditional way through a zero interest rate policy (ZIRP) alone. This in turn can help spur lending, in addition to inducing market participants to invest in industrial capital or equities. All of the “money printing” the Federal Reserve is doing is going straight into reserves the banking system holds, and in exchange the FED receives treasury bonds. If one understands banking, then one would understand that reserves are not and cannot be lent out to anyone. Nor can it magically enter the economy, as many seem to implicitly imply. For more information on QE (and preferably before reading any more of this article), read this, and this one as well to understand the mechanics of having a sovereign currency.
So how then has QE helped inflate commodity prices? Note that I said “helped”. The answer lies in inducement effects (or effects that influence one to do one thing or another). The idea of a QE program goes back to Irving Fisher and John Maynard Keynes. Keynes argued, when referring to the effects of a potential QE/ZIRP program as a response to debt-deflation, that “in a time of slump…a very excessive price for equities is not likely to occur” (Keynes, 1930). Note well that he refers here to “equities”. So how can one explain this phenomenon in agricultural and energy (among other) commodities today? The answer, as I and many others have outlined elsewhere, lies in the fact that energy commodities have become financialized. Where QE comes into the picture, then, is through the inducement effects it has through interest rates. The question becomes (as a result of QE): Who wants to earn near 0% on a security? The financial industry decided that they needed to find a new asset class in their hunt for yield.
Yet to have an effect on commodity prices one needs to have an enormous amount of influence. The financial sector taken as whole needed a new source of income with consumers deleveraging and unemployed, and one option was to enter commodities. Hence, ZIRP, QE, and the financial crisis took the financial sector in the only direction it was able to go. Through successful advertising (and institutional investors and others worried about the potential effect QE may have on inflation), the stage was set for commodity prices to soar. Goldman Sachs and hedge funds invest in commodities not necessarily with their own funds but through their clients’ funds. The impetus for doing this on behalf of its clients was 1) the insatiable demand for alternative investments, and 2) to earn fee income for providing this service. Yet remember also that the drive towards alternative investments like commodities was due to two main factors: financialization, and deleveraging and unemployment in the real sector.
In sum, the argument that QE is directly responsible for the rise in commodities and a range of other assets lacks a transmission mechanism; the key to understanding the determination of commodity prices lies elsewhere. The useful myth in this entire charade of a debate to justify higher food and energy commodity prices is that there is rising demand and lower supplies. Yet energy supplies (like oil) throughout the world are plentiful and filled to the brim. Supply and demand arguments are simply not working here. In my opinion, this is due to three (sometimes related reasons): 1) The information on food and energy commodities is imperfect and inaccurate; 2) Commodities futures markets rarely result in actual deliveries of the commodity (as explained in my previous post linked to above), and hence convergence between futures and spot prices has no theoretical or economic basis; and 3) the role of price discovery by futures markets is often forgotten, and if futures no longer converge to spot then prices can be divorced from actual supply and demand forces for at least the short to medium run. Due to these factors and the uncertainty surrounding commodity prices, the futures price has become even more engrained as the benchmark for pricing among commodity producers. The only thing restricting higher prices is the very thing that created these alternative investments: the lack of income and jobs for consumers. To ensure that the commodity gravy train lasts for as long as it can, hedge funds, investment banks, and many countries like China have bought large swaths of farmland or oil tankers (or entered into oil leasing contracts with commodity producers to restrict output). Lower supplies shown on official figures support the futures price and prevent it from collapsing. Whether a commodity producer uses a spot or futures price as a benchmark for their own pricing doesn’t matter: both prices can lack real fundamentals and/or be manipulated (for spot price manipulation in oil, see this piece).
There are some dissenters to the viewpoint that financialization in futures markets ultimately drives commodity prices. Some MMT observers see this as simply the case of monopoly/oligopoly pricing power by commodity producers. While no person can deny that the market for food and energy commodities is inherently oligopolistic, the idea that producers set the price and let quantity adjust ignores all of the detail laid out above, the rapidly fluctuating price, and the seemingly large amounts of supply on the market (at least for oil). Some non-MMT observers argue that futures markets require someone to go short and to go long, yet misunderstand that investment banks and hedge funds typically take both sides of the trade. They also argue that futures markets derive their value from spot prices, but as I mentioned above this argument no longer has any basis in reality. Note that neither I nor the dissenters make any comment about QE: there is no transmission mechanism other than inducement effects to make the argument that it drives commodity prices.
There are many solutions to bringing down high commodity prices (prices which have (helped )produce the Arab Spring (as Egypt is a primary commodity importer) and reduced output and employment worldwide). The solution that MMT incorporates into its framework is that of the Job Guarantee (JG) or Employer of Last Resort (ELR). Even in the presence of QE, food and energy commodity prices should slowly begin to reflect fundamentals as investment is driven towards real production rather than to commodities (as a result of higher incomes through an ELR program). At first blush this may seem counterintuitive, as nothing has been done surrounding the issue of manipulation and speculation. The existence of higher incomes will increase demand, lower supply, and increase prices. Yet this ignores the fact that investment is being driven towards commodities due to low returns elsewhere (low yields and high unemployment). Hence, financialized investment in commodities should slowly drift away as a result of an ELR program.
MMT provides not only a description for why QE has no direct transmission mechanism towards higher commodity prices, but also a prescription for how to lower commodity prices and hence bring price stability. Ironically enough, it is through an ELR program (where full employment beyond the non-accelerating inflation rate of unemployment is typically credited with inflation in mainstream economics), and not monetary policy or the futures market (both of which respectively are credited for price stability in mainstream economics), that can provide for stability in commodity prices in addition to full employment and output.
I welcome any and all comments, particularly on the theoretical proposition that a JG brings stability to commodity prices.