Chairman Ben Bernanke has announced that the Federal Reserve will buy about $600 billion of government bonds as part of what is being called QE2 (because this is the second big stage of “quantitative easing”).
This actually isn’t printing money, but it has the same effect in that it creates more liquidity by putting more money into the financial system. The theory is that all this extra money will drive down interest rates, and that lower interest rates will encourage people to take on more debt to finance additional spending.
There are several reasons why this is a bad idea and one potential argument why it is a good idea.
* It is a bad idea because rising prices are the inevitable result when there is more money chasing the same amount of goods.
* It is a bad idea because it assumes that the economy is weak because of high
low interest rates. That is nonsense. Interest rates already are very low. Trying to drive them lower in hopes of stimulating borrowing is like pushing on a string.
* It is a bad idea because you don’t solve bad fiscal and regulatory policy with bad monetary policy. The economy is weak in considerable part because of too much spending, new health care interventions, and the threat of higher taxes. You don’t solve those problems by printing money, just like you don’t make rotting fish taste good with ketchup.
* It is a bad idea because the easy-money policy of artificially low interest rates helped create the housing bubble and financial crisis, and “hair of the dog” is not the right approach.
* It is a bad idea because no nation becomes economically strong with a weak currency.
* It is a bad idea because it may lead to “competitive devaluation,” as other nations copy the Fed’s misguided policy in hopes of keeping their exports affordable.
So what about arguments in favor of the Fed’s policy? There’s only one possible reason to support Bernanke’s policy, and at least one monetarist friend has offered this as justification for what is happening. I hope he’s right.
* The only legitimate argument for quantitative easing is if more money needs to be put in the system to counteract deflation. In other words, if the Fed focuses on its one appropriate responsibility – price stability, and if there is a legitimate concern of falling prices in the future, then an “easy-money” policy today could offset that future deflation.
By the way, some people say that the stock market’s recent performance is a sign that Bernanke’s policy is good for the economy. This is wrong because it confuses portfolio shifting with long-term economic performance. When the Fed creates liquidity, that drives down interest rates. What does that mean for investors? Well, it means that putting money into bonds will yield a lower return, so the only other major option is stocks. That is why Fed policy often leads (seemingly inexplicably) to short-term results that are at odds with the long-term consequences.
Here are some excerpts from a Bloomberg report.
Federal Reserve Chairman Ben S. Bernanke said the central bank must focus on the U.S. rather than overseas economies when trying to spur the recovery by purchasing an additional $600 billion in Treasuries. …Bernanke came under fire yesterday from officials in Germany, China, and Brazil, who said his plan to pump cash into the banking system may jar other economies and fail to fuel U.S. growth. Critics including Michael Burry, the former hedge-fund manager who predicted the housing market’s plunge, have said Fed policy is encouraging investors to take on too much risk and threatens to undermine the dollar. …“We are showing insufficient stimulus,” Bernanke said yesterday in his remarks, mostly in response to questions. Asset purchases have “the goal of reducing interest rates, providing more stimulus to the economy and, we hope, creating a faster recovery and an inflation rate consistent with long-run stability,” Bernanke said to students.