On Monday, Chicago Fed chief Charles Evans joined his counterparts in Boston and San Francisco in calling for open-ended asset purchases. Like Boston's Eric Rosengren, Evans believes that the Fed should expand its balance sheet continually until certain economic outcomes are achieved. Specifically, Evans says that asset purchases should persist until the jobless rate falls to 7% and should only be reconsidered in the event inflation rises above 3%. Evans claims that if the Fed doesn't act the unemployment rate will remain above 7% until at least 2015.
There are two important points to note about this position. First, there is something terribly ridiculous about the assertion that the duration of asset purchases should depend on specific economic outcomes. The obvious question to ask becomes: "What if asset purchases turn out not to be the proper way to achieve those outcomes?" In that case, does the Fed sanction the infinite expansion of the balance sheet if circumstances should conspire to keep unemployment above 7% but inflation remains below 3%?
Second, if $2.3 trillion in asset purchases have only managed to shave 1.7% off the unemployment rate from its peak in October of 2009 until today, one certainly wonders, given the diminishing nature of the economic returns (the jobless rate has begun to creep up again since April), how much more the Fed will have to buy to drive unemployment to 7% or below.
Of course the bigger issue is whether or not the Fed even truly cares about the economic outcomes it claims to be watching so closely. Given the seemingly high correlation between Fed actions and rumors and stock market returns, the whole thing appears to be a (very) thinly veiled attempt to keep equity markets inflated and maintain the mechanisms whereby banks are allowed to borrow money for nothing, buy long term Treasury bonds yielding considerably more than nothing with the free money, then sell them back to the government (Operation Twist) as soon as they spot better opportunities. Meanwhile, the public can't borrow for 0% and thus can't execute the same carry trade and is forced to choose between parking money at the bank at extraordinarily low, or even negative real interest rates, or put the money into the inflated equity market where High Frequency Trading algos skim billions off the top. This dynamic is discussed further in "The Rot Runs Deep" By Charles Hugh Smith.
Even when the financial media does draw attention to the fact that QE is doing very little in the way of producing desirable economic outcomes, the stories are littered with references to its positive effect on the stock market. Consider the following excerpt from Bloomberg:
"QE is not a panacea for the U.S. or the global economy, because its effects on the U.S. economy are likely to be relatively small."
Thank you Bloomberg. Of course preceding that little kernel of truth-telling, is the following passage:
"Some of the impact of QE3 is already priced into equity markets. What's more, investors are unlikely to react as positively as in the past..."
The point is that it really isn't clear why references to the stock market should always accompany discussions of quantitative easing. It isn't really about the stock market.
Perhaps the most interesting thing about the commentary by Charles Evans however is what he said about the kind of assets that should be purchased. According to Reuters, Evans said that "any new bond-buying should focus on housing-backed bonds." So both Evans and Rosengren have publicly stated that housing related bonds should be the focus of QE3. Recall also that Bill Gross sees this as the likely form the new QE will take. It now seems abundantly clear to me (and I raised this issue in a previous article) that policymakers are setting up taxpayers to pay for the Treasury-mandated, accelerated wind down of Fannie (FNMA.OB0 and Freddie's (FMCC.OB) portfolios.
In my opinion, it seems like an extraordinary coincidence that more and more officials and commentators are calling for QE3 to take the form of MBS purchases just weeks after the Treasury announced it will force Fannie and Freddie to liquidate assets at one and a half times the previous wind down rate. If this indeed comes to pass it will be a terrible farce. The stated objective of the new policy on Fannie and Freddie was to "Make Sure That Every Dollar of Earnings Fannie Mae and Freddie Mac Generate Will Benefit Taxpayers." Recall that the idea is to "sweep" Fannie and Freddie's profits rather than continue to let them draw from the Treasury simply to pay a dividend right back to the Treasury.
Note that if any of these swept "profits" are derived from the Fed buying MBS from Fannie and Freddie then the new policy is no different from the previous one; that is, it still effectively represents taxpayers paying themselves a dividend. It isn't at all clear how the Fed printing money to buy the MBS from Fannie and Freddie and then transferring any profits to the Treasury is really "a benefit" to taxpayers. In fact, since the Fed transfers profits to the Treasury, theoretically what you would have is taxpayers buying assets from themselves, paying themselves the profit on the sale, and then holding assets on their own books that have historically been prone to decline in value.
Note also the massive transfer of debt (and risk) from the private sector to the public sector. The home loans were originated in the private sector (from banks to borrowers) and were sold to Fannie and Freddie, securitized, and put on their balance sheets. If the Fed buys these assets, they will wind up on the Fed's balance sheet. Should the Fed be forced to sell those assets at bargain basement prices to soak up excess cash in the event inflation rises, the private sector gets to buy assets it originated back at a discount once the public sector has juggled them around and taken the losses on them. This is terribly ironic because the very act of printing the money to buy them is inflationary and thus virtually ensures that they will eventually need to be sold on the cheap!
There is no guarantee things will play out this way, and this article is not meant to create a straw man argument by making a theoretical see like a certainty (i.e. obviously, the Fed may not buy MBS from Fannie and Freddie). This discussion is simply meant to demonstrate the fact that the system has become so circular and self-referential that it cannot help but trip over itself. The obvious problem is that as the circle goes round and round money keeps being printed and credit keeps expanding to keep the momentum going. Eventually the piper must be paid. One can now see how, far from "smoothing out the business cycle," too much intervention serves only to create the conditions for major dislocations. I continue to believe that policymakers are setting the dollar up for a protracted decline and thus recommend investors position accordingly in gold (GLD) and other inflation hedges. In whatever form it takes, QE3 will contribute to this reality.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.