The author implies that quantitative easing lets governments magically pay off debt. Rest assured: no liability has actually been reduced. By Daniel Shuchman Oct. 29, 2014 6:26 p.m. ET John Lanchester is on a mission to help all those who find economic and financial jargon to be confusing, even indecipherable, for whom hearing about “gross domestic product” or “the Volcker Rule” is as headache-inducing as trying to understand quantum mechanics. For Mr. Lanchester was once in the same predicament. Mr. Lanchester, a British novelist, found himself at a loss some years ago while preparing for a writing assignment on London banks. He began immersing himself in financial newspapers, and whenever he didn’t understand a complex term, he says, he would “ Google it” or consult books on the subject. Through this process of self-education, he assembled “How to Speak Money,” a compendium consisting of short entries on everything from “AAA” debt to “zombie banks.” It not only includes fundamental terms, such as “balance sheet” but also arcane ones, like “Kondratiev cycle” (an early 20th-century theory about long-term waves in economic history). Mr. Lanchester’s stated goal is to get to the essence and plain meaning of things. He reminds us, for example, that the literal definition of a “mortgage” is “dead pledge” and observes that, if the product was known by that dark description, the phrase might remind home buyers that a mortgage is in fact a “highly leveraged form of long term borrowing” with potentially dangerous consequences. There are flashes of irreverent humor, as when the author likens the central-bank tactic of telegraphing “forward guidance” of its future policy to children making “their parents promise to do something, and the parents promise that they will, and then add, ‘unless we change our minds, forget, or can’t be bothered.’ ” His tone is casual, even hip—he refers to an Italian economist as “dude” and punctuates an obvious point with “well, duh.” But like a subprime mortgage with a teaser interest rate, this book contains pitfalls for the unwary. Indeed, most entries offer less information than could be obtained in one of the author’s original Internet searches: A “bear market” is one that “has dropped 20 percent or more from its high point.” Period. Nothing about any particular bear markets, or how long they last, or why they occur. Moreover, one wonders what the reader who needs a review of what “yield” means will make of the discussion of the Black-Scholes model, the complicated formula that (as the author puts it) “made it possible to create prices in the derivatives markets.” More troubling are entries that are inaccurate, or at least imprecise, such as the author’s description of a stock buyback. This corporate action has the potential—subject to numerous variables such as valuation, projected growth rates and financing costs—to enhance per-share value for stockholders who choose not to sell their shares. Without even discussing these factors, Mr. Lanchester posits a transaction where all shareholders tender an equal proportion of their holdings. He then erroneously asserts that new wealth has been created, when what he actually describes is essentially just a paper-shuffling exercise. On perhaps the most salient macroeconomic issue of our time—“quantitative easing”—the author’s explanation is subtly but profoundly misleading. Quantitative easing is the process by which central banks acquire government bonds in exchange for newly created money (technically, “bank reserves”), in order stimulate the economy. There is a cognitive dissonance at the core of QE, in that one instrumentality of the U.S. government (the Federal Reserve Bank) acquires securities issued by another branch (the Treasury Department). But the distinctions between these two parties are essential to understanding the strategy. Yet Mr. Lanchester refers to QE as “the government” engaging in “buying back its own debt”—a simplification that is sloppy at best. Even worse, when Mr. Lanchester analogizes QE to an individual who has the power magically to add money to her bank account and uses it to “pay off” her debts, he is leading the reader seriously astray. For rest assured, no debt has been paid off in QE; all $18 trillion in U.S. government debt remains outstanding even after the Federal Reserve acquired $2.5 trillion of it. Indeed, untold mental strain is being expended to figure out how to resell it. If Mr. Lanchester possesses information that the Federal Reserve has secretly forgiven the debt it has acquired, as a gift to the U.S. Treasury, he is sitting on a financial scoop of epic proportions. Eventually one discovers the unifying theme of the book: The author’s obsession with income inequality. Many seemingly innocuous glossary terms (such as “Laffer Curve” and “mean and median”) are merely pretexts to pivot from what should be relatively straightforward definitions into contrived segues about the issue—which, he is convinced, “is certain to dominate discussion of politics and economics over the next decade.” Most revealing is Mr. Lanchester’s entry for “externalities,” the concept that some economic activities (such as an unregulated fertilizer plant that spews chemical waste into a river) create costs for people “downstream.” He invents a radical new application for the term, casually asserting that “very high levels of pay in the financial sector have an impact on inequality and therefore on the quality of life of the community” and are therefore also a negative externality. How high pay is morally or economically comparable to pollution is left unexplained, as is the basis for thinking that high income in a single sector of the economy should be categorized this way. Surprisingly, one phrase you won’t find in Mr. Lanchester’s A-to-Z is “free lunch”—the economist’s dismissive formulation of the idea that you can get something for nothing. Yet that is what “How to Speak Money” aims to provide, supposedly packing in everything a weary novice needs to know in a mere 268 pages. When it comes to economic and financial education, there is no free lunch. Should you rely on a book that promises one? Well, duh. Mr. Shuchman is a New York fund manager who often writes on law and economics.
Posted on: Sat, 08 Nov 2014 00:57:50 +0000
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