Last fall, Federal Reserve Chairman Ben Bernanke launched QE2 (Quantitative Easing 2) in order to stimulate U.S. economic growth. Now that the preliminary fourth quarter 2010 data is in, it is possible to start evaluating how he is doing. His apparent goals, as I noted in a November 19 commentary (Will QE2 End in Disaster?), were to cause inflation in order to suppress private savings and increase consumption and to weaken the dollar in order to increase U.S. exports and reduce U.S. imports. I wrote:
QE2 is designed to reduce American private savings and also to cause private foreign savings to flee from the United States. Its goal is to increase inflation from its current 1% to at least 2% or 3% while keeping short-term U.S. interest rates close to 0%, producing an “inflation tax” upon private American and foreign savers.
Bernanke hopes that reducing private American savings will increase American consumption and that sending private savings abroad will improve America’s trade balance....
Inflation, Savings and Consumption
One of Bernanke's goals was to increase inflation to 2%, which he confirmed in a November 19 speech. With U.S. short-term interest rates close to 0%, the increased inflation rate would place a 2% inflation tax on short-term savings. This would cause the savings rate to fall, which in turn would cause consumption to increase.
He has been succeeding at increasing inflation. The Consumer Price Index climbed from a 1.1% rate in September to a 1.5% rate in December, and the Producer Price Index climbed from a 0.4% rate in September to a 1.1% rate in December. The only anomaly is the BEA's GDP deflator which decreased from a 2.08% rate in the third quarter to a 0.33% rate in the fourth quarter.
The effect on savings was as predicted. The U.S. savings rate fell from 5.9% of after-tax income during the third quarter to 5.4% in the fourth quarter. This, predictably, increased consumption.
Dollar Strength and Trade Balance
Another of Bernanke's apparent goals was to weaken the dollar. But the effect has been mixed, as shown in the chart below:
From September 30 to November 3, the dollar weakened from 100.1 to 97.6, according to the Broad Index published by the Federal Reserve, perhaps because private savings were fleeing the United States in order to earn better after-inflation returns elsewhere.
From November 3 to November 29, the dollar strengthened from 97.6 to 101.0, perhaps because foreign central banks stepped up their dollar reserve purchases in order to keep their currencies from rising against the dollar.
Since November 30 the dollar has fallen from 101.0 to about 98.4, perhaps because foreign central banks were finding that creating new money in order to buy increased dollar reserves was causing inflation within their own countries.
The effect upon trade has been quite positive. The U.S. trade overall trade deficit (goods and services; seasonally adjusted) in September was $44.6 billion while in November it was down to $38.3 billion. The December statistics won't be out until February 11.
On November 19, I predicted that QE2 would be beneficial in the short term. I wrote:
Indeed, the short-term result of QE2 will be beneficial. Consumption will increase and private savings will flee the country for better interest rates abroad. Already, the dollar has weakened versus most foreign currencies, which makes American products more competitive in U.S. and world markets.
That prediction was correct. The preliminary GDP statistics show that the economy grew at a 3.2% in the fourth quarter as compared to a 2.6% rate during the third quarter. The growth was led by the improving trade balance and the improved consumption, both of which could be caused by QE2. These were two of the main factors cited by the BEA in its GDP press release when it wrote:
The increase in real GDP in the fourth quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, and nonresidential fixed investment that were partly offset by a negative contribution from private inventory investment. Imports, which are a subtraction in the calculation of GDP, decreased.
I don't expect the prelminary data on GDP to hold up when it is revised. First, I do not expect that the December trade data will be as positive as the November data since the dollar was stronger, on average, in December than in November. Second, I don't expect that the fall in inflation according to the GDP deflator from 2.08% in the third quarter to 0.33% in the fourth quarter will hold up. Other inflation measures (CPI and PPI) grew during that period.
As far as the long-term is concerned, I am sticking with my November 19 prediction. I wrote:
But in the long term, Bernanke’s discouragement of American savings will reduce investment in America’s economic future and his decision to increase inflation will provide a new element of uncertainty in business decision making....
There has always been, and there will always be a way for a country with a huge trade deficit to get its economy moving. All it needs to do is balance trade. Doing so would provide an economic stimulus with legs. American consumption would increase because American demand would be producing American income, not Chinese income. American business investment would increase because businesses would be able to produce goods in the United States and still sell in China.
There is a very simple way to balance trade, a scaled tariff whose rate goes up as our trade deficit with a particular country goes up, down when the trade deficit goes down, and disappears when our trade deficit disappears. Such a WTO-legal tariff would force the trade-manipulating governments to take down their many, many barriers to American products, increasing American exports while decreasing American imports.
There are three pillars of economic stability: balanced monetary growth, balanced budgets and balanced trade. At the moment, the American political establishment is not doing any of them. The result could be catastrophic.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.