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Saturday, November 6, 2010
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!.
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.
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?