There are two subtle dangers to quantitative easing (QE) that go beyond the massive build-up in bank excess reserves which could lead to an explosion in the nation's money supply and virulent inflation down the road. Before I get to them, let me say that a lot of people feel like we're watching Charlie Brown getting ready to kick the football as Lucy is placing the football in place. We've been down this road before in a different guise. Ten years ago we were assured by a prior administration that, by today, we would have balanced budgets. Well, where are they? What? We can't cut spending because of unemployment pushing 10%? The deficit is $1.3 trillion.
Today we are told that, when it comes time to reverse the QE to sell longer-term Treasuries to counter inflation, the Federal Reserve will be up to the task. Please, Charlie. Don't try to kick the ball!.
Danger I
Suppose QE is successful. Suppose the unemployment rate drops as inflation rises, but inflation is nipped in the bud as the Fed successfully reverses its policy. How could this possibly be a danger? Let's think back. Former Fed Chairman, called the "maestro" in the latter part of his tenure, was seen as the best Fed Chairman to ever hold the position. He was adept at manipulating the fed funds target rate every time the economy needed a boost or was viewed as too strong. Eventually traders came to expect a bailout by the so-called "Greenspan put." In other words, it led to excessive risk taking. We are still trying to dig out from the consequences.
Success this time will make it easier to use next time. This leads to ongoing manipulation of the economy until risk is no longer correctly priced. This is a dangerous situation.
Danger II
We are slowly digging deeper and deeper into a "do as I say, not as I do" situation. Consider Treasury Secretary Geithner's remarks:
“We will never use our currency as a tool to gain competitive advantage,” Geithner told
reporters today after a meeting of finance ministers from the Asia-Pacific Economic
Cooperation group in Kyoto, Japan.
Huh? Is there anyone who isn't pointing to the beneficial impact on the U.S. Trade Deficit from the falling dollar. On the previous quantitative easing post, Shawn Watson commented about arrogance. Are our officials not aware of how arrogant we look when we say one thing, do another, and then tell other countries how to manage their currencies?
How does a country make itself richer by debasing its currency? I don't think our employment problem has anything to do with the level of dollar, and a lot more to do with excessive regulation, the fear of central planners gone wild, and a lack of confidence in leadership.
ReplyDeleteThe ultimate central planners are the Fed and the Treasury and I have close to 0 confidence that they can fine tune the monetary engines to control inflation. When a country has piled on debt the way we have in the past 10 years (and especially the last two) inflation and debasement are the easiest ways to cure the spending disease. Of course, the cure will be very painful.
You hit the nail on the head with "...the fear of central planners gone wild".
ReplyDeleteMy prediction is that before this is all over we will end up with a gold standard. There is no discipline with policy makers and politicians with a short time horizon.
I wonder where this is going to go.
ReplyDeleteI wouldn't want gold to be centralized and controlled by the government, since it could lead to problems and would eventually break just like the original gold system did. Free-market currencies would work better.
There seems to be no present limit on how much debt will be created by the Fed Reserve and the Treasury. Everytime we hit a ceiling on the National Debt, Congress gets a mulligan and raises it. I think option II. If QE2 doesn't work, our central planning brahmins will think that they didn't do enough. So do it again, only this time, do it *harder*.
ReplyDelete"How does a country make itself richer by debasing its currency?"
ReplyDeleteA country with a lot of foreign debt in its own currency (such as the US) will certainly have positive short-term effects from debasing it. The foreign countries holding the debt will see it depreciate and the US will see it's relative debt shrink.
Of course in the long run there could be problems... foreign countries could stop accepting US dollars for example.