Federal Reserve to monetize more debt

Ben Bernanke

The Federal Reserve announced a third-round of quantitative easing (QE3), during which the central bank will purchase $600 billion bonds in hopes that the debt monetization will stimulate the economy and thus bring down the unemployment rate by one-percentage point.

The move has already been met with derision by GOP vice presidential nominee Paul Ryan (R-WI), who called the Fed’s actions “insidious” during a speech in Florida on Saturday. Before the Federal Reserve announced its decision last week, the Wall Street Journal reported that many economists expressed doubt that another round of quantitative easing would do anything to stimulate the economy. And if they do manage to do anything, it could be as, Neil Cavuto explains, “substituting bubbles”:

The risk with forcibly keeping interest rates low is you create another bubble, which is odd because we’re in the fix we’re in because we burst out of a real bad financial bubble.

My fear is that we’re substituting bubbles.

We’re encouraging the very reckless hedging and leveraging that brought on the last financial meltdown.

I’m not saying that happens again. But you don’t have to be Nostradamus to see where this kind of stuff goes. It’s inflationary, for one thing, and likely prompts a continued run-up in commodity prices that had stalled for a while.

The announcement of more debt monetization, which is exactly what “quantitative easing” is, has prompted Egan-Jones to downgrade the United States’ credit rating again, noting that the program “will hurt the U.S. economy and, by extension, credit quality.”

So what does QE3 mean? Brian LaSorsa, who expresses concern over Federal Reserve Chairman Ben Bernanke’s decision making, explains:

The balance sheet below — obtained from the Federal Reserve Bank of Cleveland — is a summary view of the central bank’s holdings. You can click the image to view the full-sized chart, or you can check out the Wall Street Journal’s interactive graphic featuring the same numbers.

Federal Reserve Balance Sheet

The amount of mortgage-backed securities is so worrisome because these assets are unstable and don’t disappear after the Fed’s purchase. The securities still exist and have to be released back into the economy at some point in the future. By temporarily flushing them out of the public’s view, the Fed is misleading certain investors and leaving other ones bearish. The release of these securities will be met with the realization that important resources are severely misallocated.

The immediate effects are more straight-forward.

Expect a strong boost to the stock market. The Fed begins purchasing assets today, and that means Wall Street investors who own mortgage-backed securities will have liquid portfolios to spend on other stocks. Typically zero percent interest rates signal you’ll want to invest in industries like banking and housing for a short time while the bubble grows, but, since interest rates are already zero bound, the situation is stickier.

Currency dilution also signals that gold and silver prices will increase. They’ll be used as a hedge against the impending price inflation. Any metal with intrinsic value — the currency advocated by Austrian School founder Carl Menger — will likely follow this pattern.

The Federal Reserve, as George Will explained on Sunday, has become the fourth branch of government, acting upon its own desire with little congressional oversight. The great power it wields over the economy is very concerning. As I’ve written before, Ben Bernanke and others at the Federal Reserve believe that they can create the sort economy they want, but again, this is the third-round of quantitative easy, not to mention that many other tricks were employed during the financial crisis in hopes making the recession as painless as possible.

In his book, The Fatal Conceit, F.A. Hayek wrote, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” There is no better example of this than Bernanke and the Federal Reserve.

After all the actions the Federal Reserve had taken up to June 2011, a dumbfounded Bernanke said, “We don’t have a precise read on why this slower pace of growth is persisting.” Central planners don’t want to admit it, but the economy doesn’t function the same as the economic models they use to concoct these half-baked. They’re dealing with real people who know when something is wrong. Many, if not most, of the problems the economy is facing are out of the grasp of the Federal Reserve.

The Federal Reserve can manipulate the money supply and monetize debt; however, they don’t control regulatory, spending, tax policies that are causing many businesses hesitation to hire and invest. What they can do, however, is create another bubble, but then the Fed is right back where it started and looking at dealing with painful economic problems again, just later down the road.

GIF image courtesy of Ron Paul Problems.

 
 


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