[Given the Fed’s most recent] statement at the end of their meeting last week in which they said: “The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate” (Translation: ‘inflation may be getting too low, but don’t worry, we are on the job’) it seems to be setting us up for another round of quantitative easing. That is Fed speak for buying a few trillion or so dollars of government debt and injecting said cash into the economy. Words: 1147
So says the John Mauldin (www.frontlinethoughts.com) in a recent article* which Lorimer Wilson, editor of www.FinancialArticleSummariesToday.com, has reformatted into edited […] excerpts below for the sake of clarity and brevity to ensure a fast and easy read. (Please note that this paragraph must be included in any article reposting to avoid copyright infringement.) Mauldin goes on to say:
Degree of Growth in the U.S. Economy is the Key
The key driver for whether the Fed enters into another round of quantitative easing… is the growth in the U.S. economy. If we are above 1.5-2%, I think they will hesitate, for reasons I go into below. If we drop below 1% and it looks like we are getting weaker, then they are likely to act. A slide into recession would bring about deflation, [something] the Fed is viscerally opposed to. The question in my mind, [however,] is whether a few trillion dollars spent purchasing government debt would do the trick. What if they sent out invitations to an inflation party and nobody came? Let’s look at some data points.
How Effective Was Last Year’s QE?
The Fed purchased $1.25 trillion in mortgage assets last year. The theory was that injecting money into the economy would cause banks to take that money and lend it, jump-starting the economy and bringing us back into a normal recovery. Let’s see how the lending part went. [Visit the original article* for charts.] a) Bank Credit of All Commercial Banks – down;
b) Total Consumer Credit Outstanding – [stagnant];
c) Commercial and Industrial Loans at All Commercial Banks – down;
d) Total Residential Mortgages – down;
e) Credit Card Debt – down;
f) Commercial Mortgages – down
g) Commercial Property Loan values… rose to a NEW HIGH. (No wonder commercial mortgages are down.)
So, what happened to the trillion-plus dollars?… It went back onto the balance sheet of the Federal Reserve, i.e. banks put it back into the Fed… If banks are not lending now, with what seems like lots of reserves, then what is to make us think that another $2 trillion in QE will make them feel like they have too much money in their vaults?
a) If it is because they don’t have enough capital, then adding liquidity to the system will not help that.
b) If it is because they don’t feel they have creditworthy customers, do we really want banks to lower their standards? Isn’t that what got us into trouble last time?
c) If it is because businesses don’t want to borrow all that much because of the uncertain times, will easy money make that any better? As someone said, “I don’t need more credit, I just need more customers.”
How Effective Would Additional QE Be?
How much of an impact would $2 trillion in QE give us? Not much, according to former Fed governor Larry Meyer…[who has conveyed via Morgan Stanley that the Fed] maintains a large-scale macro-econometric model of the U.S. economy that is widely used in the private sector and in public policy-making circles. These types of models are good for running ‘what if?’ simulations. Meyer estimates that a $2 trillion asset purchase program would:
1) lower Treasury yields by 50bp;
2) increase GDP growth by 0.3pp in 2011 and 0.4pp in 2012; and
3) lower the unemployment rate by 0.3pp by the end of 2011 and 0.5pp by the end of 2012.
What Would Implications Be For U.S. Dollar?
[The above] is not much bang for the buck, so to speak, but it would be pointing a gun with a very big bang at the valuation of the dollar. If QE were attempted on that scale, it would not be good for the dollar. My call for the pound and the euro to go to parity with the dollar would be out the window for some time, and maybe for good.
Now, if the strategy is to lower the dollar, then QE might make some sense; but of course no one would admit to that, not when we are accusing other countries of manipulating their currencies (as in China). No, we would just be fighting deflation. The fact that the dollar dropped would just be a coincidence, a necessary but sad thing in the important fight against deflation. (Please note tongue firmly in cheek. Not you, of course, but some other readers sometimes miss my sarcasm.)
If the economy is recovering then QE is not needed and the US economy in the current quarter may be doing better than last and… the bank lending charts I presented [in the original article*]… might [suggest] a bottom forming and even some increase in lending. Perhaps we have turned the corner.
What Would Implications Be For The Economy?
What if the Fed went ahead and threw $1-2 trillion against the wall? If it showed up back at the Federal Reserve, it would only serve to show that the Fed does not have the tools it needs, or would have to be really willing to monetize debt. It would be Keynes’ “liquidity trap” or what Fisher called debt deflation. Neither are good. That’s called pushing on a string. If the markets sensed that, it would not be pretty.
The Fed has been buying government debt for several months, taking the money from the mortgages that are being amortized and buying the debt. Let’s maybe see how that works out before we bring out the big guns. Just a thought.
If the economy continues to weaken, I think it is likely the Fed will act preemptively and start QE2 so the next few months of economic data are very important – and even more important is whether Congress will extend the Bush tax cuts at least until the economy is growing respectably. Not extending them would be a policy mistake bigger than QE2, and might force even more precipitous action.
*http://www.frontlinethoughts.com/printarticle.asp?id=mwo092410 (John Mauldin, best-selling author and recognized financial expert, is also editor of the free Thoughts From the Frontline that goes to over 1 million readers each week. For more information on John or his FREE weekly economic letter go to: www.frontlinethoughts.com/learnmore)
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