Ben Bernanke last week announced what could presumably be summed up as QE3. (Given its open-ended nature, I prefer to call it QE Infinity.)
So, let me ask you this: are you happy? Or do you feel like you do after a night of drunken debauchery? Do you feel cheap, exposed and vulnerable?
What if Bernanke hadn't announced QE3? Is that the only thing keeping markets from crashing?
Most of us have realized by now that the world economy hangs by a string that central banks keep pushing against. But as the figure of speech implies, it is far easier for a central bank to affect an economy through tighter policy (pulling on a string) than looser policy (pushing on a string). These dynamics of the monetary policy transmission mechanism can turn expansionary monetary policy into a guessing game. This is what we're seeing today.
Let me clarify: central banks around the world are guessing when they create policy. If the central banks knew the 'correct' prescription to send the economy back to health, don't you think central banks would have issued that in the first place? This is the reason that every new expansionary policy announcement is different from the last. They're trying everything in the hopes that something sticks. This week's announcement was particularly inventive in that it was 1) indefinite, 2) linked to unemployment and 3) suggested policy will remain accommodative even if things got better.
This week's announcement also smelled of desperation.
So what's driving Bernanke and friends to keep spraying the monetary fire hose? Two things:
1. As a student of the Great Depression, he is scared pants-less of the economic abyss that we could fall into if deflation ever took hold.
2. He is the handmaiden of US fiscal policy. Let's not mince words: the Fed is indirectly monetizing the US deficit via the agency MBS market. Debt is being created in massive amounts, but is indirectly absorbed by the Federal Reserve, which is buying the government's 'off balance sheet' mortgage liabilities, thus keeping interest rates low. Unfortunately, this will only serve to devalue the dollar, raise import and raw materials costs, and pressure consumer spending, which - according to Egan-Jones - is reason enough to cut the US debt rating from AA to AA-.
Couldn't this work? Perhaps some extra money is all the economy needs to lower unemployment? I say no.
We are not dealing with a typical slowdown in which capital is idle but waiting to reignite with a rebound in demand. Instead, the whole system is trying to shrink (delever, if you will), which is why even a fire hose of liquidity can't fill the economic abyss. Except for those who own financial assets and commodities, very few average people have benefited from quantitative easing over the past few years. We are stuck in a liquidity trap.
An economy trying to shrink needs fewer people to make and sell stuff. The level of structural unemployment rises and 'official' unemployment rates of 6, 7, 8% become the new norm. Nobody is buying stuff, businesses are hoarding cash, and only prime credits get cheap money from banks. So where does all the extra money flow? Into the financial system, either at the Treasury, in financial assets or commodities or as reserves held at the Fed.
With unemployment around 8% (with a pitiful participation rate), while the S&P 500 approaches its 2007 high (see chart below) and gold nears its 2011 peak, it is quite clear that quantitative easing has benefited Wall Street over Main Street.
Good luck to those believing more money printing - even if tied to unemployment - will actually reduce unemployment. All the money in the world won't force businesses to hire people they truly don't need. Even if businesses did hire people they didn't need, this would be a gross misallocation of capital and we'd be worse off for it.
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