Best of the Week
Most Popular
1.Stock Market Continues Defying Gravity, Dow New All Time High - Nadeem_Walayat
2.America Superpower 2016 - Ian Bremmer
3.The US Dollar and the Precious Metals Complex - Rambus_Chartology
4.UK Immigration Crisis Could Prompt BREXIT, Propelling Britain Out of EU Despite German Factor - Nadeem_Walayat
5.The “Real Flash Crash” Will Scare You to Death - Shah Gilani
6.Gold Price Trend Forecast - Bob_Louka
7.UK Deflation Warning - Bank of England Economic Propaganda to Print and Inflate Debt - Nadeem_Walayat
8.Gold Lifeboat to Global Economies “Titanic Problem” Warn HSBC - GoldCore
9.Will Interest Rates Ever Rise? - BATR
10.Who’s Killing the Stock Market? - Shah Gilani
Last 5 days
This New Currency Could Wipe Out the Euro - 28th May 15
US Housing Market - Something Smells Fishy - 28th May 15
US Economy – Semi b2b Amps Up its Trend - 28th May 15
U.S. Fed Exported QE Travesty: Meet The BLICS Nations - 28th May 15
World War D—Deflation - Secular Bear Markets Analysis - 28th May 15
George Soros Warns of “Third World War” - 28th May 15
Why You Shouldn't Try to Invest Like Warren Buffett - 28th May 15
Stock Markets Buy and Hold is Back! - 28th May 15
We're Now Frighteningly Vulnerable to a Bond Market Crash - 28th May 15
Austerity, Economics and Religion - 28th May 15
National Holidays London and the Magic of Legoland UK Review - 27th May 15
Imminent Stocks Bear Market Signaled by Dow Theory ... - 27th May 15
Gold Price Has Bottomed – More Evidence - 27th May 15
Three Reasons You Shouldn’t Try to Invest Like Warren Buffett - 27th May 15
Gold Is “100% Guarantee from Legal and Political Risks” States Russian Central Bank - 27th May 15
Don't Drown in the Sea of Global Debt - 27th May 15
Three Reasons Why Carl Icahn Is Wrong About Apple Stock - 27th May 15
Crude Oil Price Stochastic Signals - 26th May 15
Why the Stock Market Will Crash - 26th May 15
GDP, Inflation, Employment Economic Statistics: It’s All a Lie - 26th May 15
Introduction to Peak Food - 26th May 15
Should We Dump the Euro? - 26th May 15
A Geopolitical Net Assessment of Europe - 26th May 15
Stock Market Top in Place? - 26th May 15
Best Cash ISA SBI 2.3% - 2.8 Year Fix, UK Interest Rates 2016 - 26th May 15
China Sets Up Gold Bullion Fund For Central Banks - 25th May 15
Is The Silver Trade Getting Crowded? - 25th May 15
Money Murder Mystery: Who Killed the Stock Market? - 25th May 15
Why Do We Celebrate Rising U.S. House Prices? - 24th May 15
Mario Draghi’s Slippery Downward Slope - 24th May 15
Gold : Truth is Stranger than Fiction - 24th May 15
Facebook Stock Price Forecast - 24th May 15
Make a Killing on the Coming Energy "Debt Bubble" - 24th May 15
Stock Market SPX Uptrend Inflection Point - 23rd May 15
What You Know for Certain - Huge Demand for Gold And Silver - 23rd May 15
Are We in Another Credit Bubble? And Is It Different than Before? - 23rd May 15
The “Real Flash Crash” Will Scare You to Death - 23rd May 15
Venezuela: No Rule of Law, Bad Money - 23rd May 15
Robots That Can Beat the Market by 100% - 23rd May 15
Why Shake Shack Stock Is a Bad Investment - 23rd May 15
Gold Price Primary Driver Bullish - 23rd May 15

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

Biggest Debt Bomb in History

Bernanke's $4 Trillion Quantitative Easing Dilemma

Interest-Rates / Quantitative Easing Oct 26, 2010 - 10:16 AM GMT

By: Mike_Whitney

Interest-Rates

Best Financial Markets Analysis ArticleBen Bernanke is in a real fix. His quantitative easing (QE) program is designed to boost stock prices, lower bond yields, and weaken the dollar.

But the market has already priced all that in, so when he announces the start of the program on November 3, there's a good chance that things will either stay the same or head in the opposite direction. That's bad for Bernanke. Just imagine if the dollar strengthens just as the Fed chairman begins buying-up Treasuries to push the dollar down. He'll look pretty foolish. But that could happen because the dollar has already slipped nearly 7% since August and is overdue for a rebound.


So, what should he do? Should he go ahead and launch his program anyway knowing it could backfire and further damage his credibility or scrap the whole deal and move on to Plan B?

The truth is, he has no choice. If he doesn't follow through now, investors will accuse him of "withdrawing liquidity" and send the market into a nosedive. So, he has to go forward and let the chips fall where they may. If QE2 turns out to be a bust, so be it.

A new report from Goldman Sach's economist Jan Hatzius figures that "the Fed will need to print $4 trillion...to close the Taylor gap." (zero hedge) That means it will take roughly $4 trillion for QE to do what it's supposed to do. New York Times columnist Paul Krugman's estimates are even higher. He thinks it will take $8 to 10 trillion of QE to push down long-term rates enough to sustain the recovery. Of course, no one is even considering expanding the Fed's balance sheet by that amount because it would put the central bank's future at risk and might not work anyway. Instead, Bernanke plans to take baby steps, purchasing $200 to $300 billion in Treasuries at a time, hoping that the smaller amounts buoy stocks and increase investment in the real economy. In other words, QE2 is not a really serious commitment of resources to address deflationary pressures, excess capacity or high unemployment at all. It's more like giving aspirin to a cancer patient. There may some temporary relief, but the overall effects will be negligible.

That's not to say that the Fed isn't a powerful institution. It is. The Fed controls short-term interest rates and short-term rates can either stimulate growth or send the economy into a tailspin. They can guide the economy to years of productivity and prosperity or generate gigantic speculative bubbles that end in disaster. But, in a liquidity trap--when interest rates are stuck at zero—monetary policy is largely ineffective so the Fed is dead-in-the-water. It doesn't matter how cheap money is when people aren't borrowing. And, people aren't borrowing because they're broke. The Fed doesn't have the ability to change that. Bernanke may wish he was "Helicopter Ben" and could drop bundles of greenbacks over America, but the truth is, only congress has that power and they're not taking advantage of it. They're more worried about deficits.

So, QE won't succeed because it doesn't address the real issue, which is demand. In theory, when the Fed buys bonds, it pushes investors into riskier assets, like stocks. That, in turn, inflates equities prices which (supposedly) triggers additional hiring and lowers unemployment. It's a persuasive theory, but it won't work. Here's an excerpt from an article in the Wall Street Journal which explains why:

"While more quantitative easing will help to keep interest rates low, primary dealer banks aren't fully convinced that the move will prove to be the U.S. economy's knight in shining armor.

"It may help to lower rates temporarily," said Ward McCarthy, chief financial economist and managing director of the fixed-income division at Jefferies & Co. in New York, "but is unlikely to have a significant beneficial effect on the economy."

That is because such a program won't ease credit conditions for small businesses that are dependent on banks for lending, he said, nor will it lower borrowing costs for homeowners who are unable to refinance their mortgages because home prices have fallen." (No Fix in Quantitative Easing, Deborah Lynn Blumberg, Wall Street Journal)

So, if QE doesn't help small businesses (which create most of the country's new jobs) or homeowners, than how can it lower unemployment, trim excess capacity, or increase aggregate demand? It can't. At best, it will merely boost asset prices and create more bank reserves while the real economy continues to languish in a near-Depression.

Naturally, the prospect of the Fed adding trillions of dollars to the money supply has trading partners in a panic forcing some to regulate capital inflows and prepare for a savage round of competitive devaluation. At this weekend's meeting of the G-20 in Gyeongju, South Korea, German finance minister, Rainer Brüderle lashed out at the Fed's QE program saying, “Excessive, permanent money creation in my opinion is an indirect manipulation of an exchange rate.” The irony of the Brüderle's remarks were lost on Treasury secretary Timothy Geithner who used the meetings to point the finger at China and to make his case for "numerical limits" on current account balances. This is from Bloomberg:

"Seeking to find common ground on currency valuation, officials agreed to “move toward more market-determined exchange rate systems that reflect underlying economic fundamentals.” And they pledged to “refrain from competitive devaluation of currencies” — an effort to calm anxiety over a wave of protectionism in which countries would weaken their currencies to bolster their own exports."

It makes you wonder how the attendees could listen to Geithner's disingenuous blather knowing that the Fed is planning to print up hundreds of billions of dollars that could wreak havoc in the currency markets?

Even so, Geithner is right to be worried about the widening trade deficits. The massive imbalances inevitably lead to crises as they did when Lehman defaulted and global trade plummeted. In the last decade, US exports to China have totaled just $417 billion while Chinese imports have soared to $2,160 billion. Much of China's earnings have been recycled into US Treasuries to keep the price of their currency artificially low while they add to their $2.6 trillion in reserves. This gives them an unfair advantage in competing head-to-head with better-paid US workers.

In August, the trade gap widened more than analysts had predicted to $46 billion putting more pressure on the Fed to weaken the dollar so that more US jobs are not lost to foreign competitors and so that monetary stimulus (designed to kickstart the US economy) is not siphoned off via the trade deficit.

The bottom line: Economic recovery is impossible unless exchange rate issues are resolved. Bernanke may think that QE2 will scare China into reversing its current policy (and agree to move toward more market-oriented exchange rate system) but it's just as likely that Beijing will follow the dollar downward buying up even more US Treasuries and undermining any hope for a rebound in the US. That means that congress must get involved and threaten to levy import duties and tariffs on China if they refuse to let their currency appreciate.

Congress also needs to acknowledge the limitations of monetary policy. QE is not the right tool for dealing with a "balance sheet recession". (when households are reducing their debts and slashing spending) A second round of fiscal stimulus is the only way to lower unemployment, increase spending, and lay the groundwork for a sustainable recovery.

By Mike Whitney

Email: fergiewhitney@msn.com

Mike is a well respected freelance writer living in Washington state, interested in politics and economics from a libertarian perspective.

© 2010 Copyright Mike Whitney - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Mike Whitney Archive

© 2005-2015 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Biggest Debt Bomb in History