Quantitative easing, or why I don’t think it’s as rosy a picture as Bernanke paints

helicopter ben

Helicopter Ben is back…. (Cartoon by BlueWire Studio.)

He’s saying, ‘we’re fine, folks, be out of this recession in no time.’ Mr. Bernanke is, I believe, attempting to control and manage consumer sentiment and spending with his cheery optimism. But then the Fed takes drastic actions, like this:

Federal Reserve to Buy $1.2T in Bonds, Mortgage-Backed Securities

The Federal Reserve said today that it will deploy an additional $1.2 trillion to try to lower interest rates and stimulate the economy, an aggressive move aimed at containing the recession.

The central bank will increase its purchases of mortgage-backed securities by $750 billion, on top of a previously announced $500 billion. It also will double its purchases of debt in Fannie Mae and Freddie Mac to $200 billion. Those steps are intended to lower mortgage rates. The announcement of the previous purchases pushed mortgage rates down a full percentage point.

The Fed also said it will buy $300 billion in long-term Treasury bonds, a step it had previously considered but had been reluctant to act on. That move will lower long-term interest rates for the U.S. government directly and, Fed officials hope, will indirectly lower borrowing costs for businesses and individuals. …

Since the last meeting of the Fed’s policymaking arm, “job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending,” the Federal Open Market Committee said in a statement. “Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment.”

“In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability,” the statement said.

Since cutting the interest rate it controls to essentially zero in December, the Fed has had to find other tools to try to combat a rapidly deepening recession. At its policymaking meeting that concluded today, the central bank left that rate at a range of zero to 0.25 percent.

The vote was unanimous, in contrast to the FOMC’s previous meeting, at which one official dissented.

My questions are — people are losing their jobs, have suffered a 40% or more decline in their home values, are maxed out on credit going into the recession … from where will the desired consumer sentiment and spending arise?  Perhaps from people recouping their investment value, at least on paper, via hyperinflation?  If a loaf of bread costs $100, then $10,000 in debt doesn’t seem so bad as when a loaf $1, does it?

Wikipedia on QE:

The aim of quantitative easing and the follow on process of deposit multiplication is to increase the amount of money in circulation by an increase of credit and thus stimulate the flow of money around the economy by increased spending. The usual method of regulating the money supply is by setting interest rates. Quantitative easing is a solution when the normal process of increasing the money supply by cutting interest rates isn’t working. Most obviously when interest rates are essentially at zero and it is impossible to cut them further.

Quantitative easing is seen as a risky strategy that could trigger higher inflation than desired or even hyperinflation if improperly used. However, some economists argue that there is less risk of this outcome when a central bank employs quantitative easing in order to ease credit markets, as opposed to when a government resorts to printing money simply to meet its own financial obligations.

Quantitative easing also creates a loaded system where the money is injected into the market from the top and trickles down, the problem is that by the time it reaches the level of the common consumer inflation has caught up with the excess money in the market, devaluing the money already possessed by these consumers. This is not the case when the money is first injected as it takes time for inflation to recognise the new money and catch up.

Wikipedia on “reflation”:

Reflation is the act of stimulating the economy by increasing the money supply

Barrons on QE:

Welcome to the macroeconomics laboratory. Where once theories were tested by econometric regressions of data that attempted to tease out relationships between perceived causes and effects, we now are in the midst of a global, real-time experiment in reflation. Policies in the past that were stumbled into now are being put in place deliberately (if not entirely with forethought.) The outcomes, however, are anything but certain.

Deliberately lowering a currency’s exchange rate is a means of easing monetary policy, especially when a central bank has run out of basis points to cut from interest rates that are at or near nil.

Cheapening a currency also is a tack described in the current Fed chairman’s famous speech in 2002 — the one that gave him the moniker Helicopter Ben Bernanke. In addition to dumping dollar bills from helicopters to expand the money supply — a visual metaphor first put forth by Milton Friedman — a central bank could print money by buying foreign currencies to lower the exchange rate.

The more direct path is to buy government bonds, which has the dual expedient of helping to finance a country’s budget gap. This has been the usual means of quantitative easing, from Weimar Germany to Zimbabwe.

My question is — didn’t the U.S. government — just last *week* — tell China not to worry?

Last week, Chinese Premier Wen Jiabao expressed concern about the value of his nation’s massive holdings of U.S. debt. Just a couple of weeks ago, Secretary of State Hillary Clinton was in Beijing reassuring Chinese officials about the safety of their investments.

In an interview with the Financial Times last month, a Chinese official let it be known how they really feel about the U.S.: “We hate you guys. Once you start issuing $1 trillion to $2 trillion…we know the dollar is going to depreciate.” But, he added, there is little alternative except for China to park its surpluses in Treasuries.

The Fed will again mull monetization through outright purchases of Treasuries at Wednesday’s meeting of the Federal Open Market Committee. So far, the Fed has discussed but not gone ahead with outright purchases of Treasury bonds in a QE trip to lower long-term interest rates.

Well, there you go.  Now they have QE’d.

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