To write a piece on the latest round of quantitative easing, or QE2, as I was asked to do, I had to attempt to shelve my personal belief that the very existence of a central bank in a free country is anathema to the concept of freedom. I say this in the interest of full disclosure. It should come as little surprise that I don’t think the Fed’s latest scheme to purchase $600 billion in longer-term Treasurys at a clip of $75 billion per month until the end of the second quarter, 2011, is going to work.
Apparently, I’m not the only one who feels this way. In an October interview with CNBC, my former boss, Stephen Roach of Morgan Stanley said, “It’s not going to work. QE1 didn’t work, QE2 won’t work and QE12 will not work.” Roach goes on to say that the notion that the Fed can undo all of this by some massive injection of liquidity is “really wrong,” and rejects the notion that American families will suddenly decide to rush out and spend.
That is my chief objection to the Fed’s QE2 manipulation. By buying bonds in an effort to keep interest rates low and “stimulate” consumers and businesses into going out and spending money, the Fed is attempting to create inflated economic activity, not real economic activity. Of course, it is also accelerating the devaluation of the U.S. dollar.
Now, if you think higher inflation, big asset bubbles like the tech-stock boom and bust of the 1990s and the more recent housing boom and bust, and an anemic U.S. dollar mean the Fed’s policies are “working,” well, I’d have to concede that you would be correct. I seriously doubt most Americans relish the notion of paying more for food, clothing and gas as a result of commodity price inflation that the weaker U.S. dollar brings. I also suspect most people aren’t too keen on watching their 401(k)s melt down again.
Here’s a quick rundown of the biggest reasons why QE2 won’t “work” in the real sense of the word.
QE2 won’t prompt consumer spending. Consumers are not going to be willing to throw money pell-mell into the economy just because interest rates will remain low for a while. Most consumers are worried about the decreased value of real assets such as their homes, and many retail investors are still feeling the sting of the market meltdown that accompanied the global economic crisis of 2008.
QE2 won’t revive the housing market. If QE2 does accomplish what the Fed wants, mortgage rates would probably fall — but likely only on the order of 25 basis points. It’s hard to see how this trivial decline in rates is going to spark a new real estate boom.
The reason people don’t want to buy houses now is not because rates are too high, but because homebuyers know there’s still tons of inventory out there that’s likely to depress home prices for years to come. There are also a significant number of existing homeowners that can’t even refinance their homes at a lower interest rate because they still are dangerously upside down.
QE2 won’t cause companies to invest
. U.S. companies are sitting on an estimated $1.5 trillion in cash. The reason they aren’t expanding isn’t because they have no access to capital. The reason for their lack of willingness to invest has much more to do with the prevailing fog of uncertainty about the economy going forward. Add to that the uncertainty prompted by political risks such as a failure to meaningfully extend the Bush tax cuts and the still unknown costs of Obama care, and you get a toxic cocktail that has virtually paralyzed any significant resurgence in corporate investment.
QE2 will cause inflation. The Fed’s renewed commitment to buy bonds is just a sophisticated way of printing more money. More money in circulation means the value of existing money evaporates. When the value of a dollar declines, it takes more dollars to buy the same amount of goods. The result is inevitable asset price inflation, and as stated earlier, that’s what the Fed would like to see. The only problem with this is that in real terms, it brings down the standard of living for all of us.
