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Fed Up: Bernanke Declares War On The Poor

September 14, 2012

This week, we saw both the European Central Bank and the Federal Reserve deliver massive amounts of stimulus to the markets.

The ECB is now backed by the 500 billion euro European Stability Mechanism facility, which has been ratified by the German parliament. This is a game-changer for Europe, as now it is finally moving toward a federalist system, similar to the one in the United States. This measure has been successful in bringing down the bond yields for Spain, Italy and Ireland to a very manageable level. And it is likely that those central banks might not even need to tap the ESM.

The big surprise this week, however, came from the Federal Reserve.

The Fed has decided to go all-out in fueling the next massive asset bubbles through its QE3 bazooka. The Fed announced plans to buy $40 billion worth of mortgage securities per month on an open-ended basis, while continuing to reinvest its income from the securities purchased during QE1 and QE2.

The following statement from the Fed shows its clear intent to support its mandate of full employment. But I fail to see how it will manage to do that “in the context of price stability” while creating asset price inflation through unabashed QE programs.

If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.

This new move by the Fed is unleashing massive amounts of money into the risk assets. Markets will now believe that, between the ECB and the Fed, all tail risks to the markets have gone.

In other words, this could mean that all the money that was hiding in the safety of U.S. Treasuries will now leave the Treasury markets and flow into equities and commodities.

If so, I would not be surprised to see a parabolic move into year-end in both gold and equities that could take the S&P 500 to 1,650 and gold to $2,000 per troy ounce by year-end.

Now here is the dangerous side to this equation. This rally will also lead oil and grains to new highs, which will results in higher gas prices at the pump and food prices at the grocery store. While employment and wages are still low, this will hurt the working class.

This massive and irresponsible Fed stimulus package by Ben Bernanke & Co. will make the rich richer by fueling their asset portfolios and bringing loads of misery to the poor, who will find it harder to make ends meet.

Besides the poor, this latest move also declares war on the retirees or those who subsist on fixed income returns from bonds. With the Fed’s monetary policy stuck at zero for another three years at least and more Federal money creating artificial demand for fixed income assets, yields will not rise for quite a while. This means that the coupons on newly issued government and agency bonds will be stuck at below inflation rates.

Another debilitating aspect of the latest round of QE is that by removing coupon generating bonds from the monetary system, it reduces the amount of money in the economy, thus reducing aggregate demand.

In summary, QE will reduce net savings of U.S. dollar holders and increase paper wealth in terms of higher equity market valuations.

While the initial reaction of the markets has been to sell the U.S. dollar, fewer U.S. dollars as a result of QE will result in the dollar eventually rallying hard, especially against the EUR. My target will be around 1.3500 before EUR/USD starts heading back down towards parity.

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Quantitative Easing Forever?

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Central bankers don’t see their mistakes.

Posted August 10, 2011
Guatemala City, Guatemala

Despite assertions that it has ended its policy of quantitative easing (QE), the Fed is unlikely to be able to do so until it also ends its zero-interest-rate policy (ZIRP). This deadly policy duo has had terrible consequences for the American economy and every country using U.S. dollars, which continue to depreciate.

It is as though the Fed were riding on the back of a double-headed monster. It cannot hang on forever, but it cannot dismount the beast without being devoured. As it is, the U.S. Treasury depends on ZIRP to fund America’s ballooning debt. As investors flee an enfeebled dollar and ponder S&P’s downgrade, the Fed is likely to be the “buyer of first resort” so that the price of Treasuries does not fall, pushing up interest rates. So with the Fed insisting that short-term interest rates will remain near zero “for an extended period,” a phrase used for the past two years, a new round of QE is almost inevitable.

Excess Liquidity

For its part, QE involves flooding financial institutions with excess liquidity to try to flatten out the yield curve and depress long-term interest rates in hopes of sparking a recovery. But QE has created a massive overhang of excess reserves in the banking system that constitute repressed price inflation. And the sums involved are truly staggering with the Fed having injected at least $2.3 trillion into the financial system since Lehman Brothers collapsed in September 2008.

From late 2008 through March 2010, the Fed bought longer-term securities worth $1.7 trillion (QE1). This included purchases of $500 billion of mortgage securities and $100 billion of agency debentures with a target of $1.25 trillion for mortgage debt. purchasing mortgage-backed securities and bailing out AIG and Bear Stearns, as well as buying other securities, led to an increase in the monetary base of 140 percent.

In November 2010 the Fed began QE2 by buying an additional $600 billion in longer-term Treasury securities, a program that officially expired at the end of June. Yet the Fed has indicated it will continue buying Treasuries using proceeds from maturing debt it already owns, allowing it to engage in continuing quantitative easing by another name.

With over $112 billion of the Fed’s government bond holdings maturing over the coming 12 months, replacement alone would involve purchases of Treasurys of over $9 billion each month. It also has more than $914 billion of mortgage-backed debt and $118 billion of debentures issued by government-sponsored enterprises (Fannie Mae and Freddie Mac). As such, this is a “stealth” continuation of QE with only a limited, if any, decrease in the money-creation process.

Last Gasp

For all the fanfare about QE, it must be said that it constitutes a last-gasp step and admission of failure of other monetary policy tools. Consider the case of Japan. Its central bank, the Bank of Japan (BoJ), began asset purchases under QE to offset deflation and stimulate its ailing economy in early 2001.

After nearly a decade of setting interest rates near zero, the BoJ realized it had been unable to conjure up an economic recovery. Then after five years of gradually expanding its bond purchases, the BOJ exercised an exit strategy from QE in 2006, only to begin again.

Last March the BoJ increased its QE program from ¥5 trillion to ¥10 trillion (about $130 billion) scheduled until the end of 2012. Recently, it announced another expansion to ¥15 trillion ($183 billion).

A child untutored in economics might think it makes no sense to continue massive increases of liquidity into the economy that have been ineffective for so long. But most central bankers and many economists demur that previous amounts were too little and more is needed.

No Growth

But the incentives that QE and ZIRP create for commercial banks make it easy to see why these policies cannot promote economic growth. On the one hand, low interest rates reduce the cost of borrowing, which should encourage more investment spending. But on the other, commercial banks pay almost nothing to borrow yet receive interest payments from the Fed to hold excess reserves, making them unlikely to extend new loans.

A sufficiently high interest rate paid on bank reserves will induce banks to choose a risk-free, interest-bearing asset rather than lending to private-sector borrowers. And so it is that commercial banks are earning record profits while making very few new loans.

The question of whether the Fed or the BoJ have an effective “exit strategy” from their policies of monetary expansion using near-zero interest rates and quantitative easing remains open. One possibility for the Fed is to engage in repurchase agreements (reverse repos) to remove some of the excess liquidity that it pumped into the financial system.

These reverse repos involve selling securities to commercial banks with the Fed agreeing to buy them back at a higher price at a later date. But once again, commercial banks will find the choice between holding risk-free, interest-bearing assets a much better bet than issuing new commercial loans.

Repressed Inflation

In the end both QE and ZIRP have been ineffective in restoring economic vitality while also creating a massive overhang of repressed inflation. Most economists view business startups, especially small- and medium-sized enterprises, as the key to economic recovery and growth. Yet QE and associated central-bank policies are diverting credit away from newly forming firms.

The Fed has now announced it will continue the “exceptionally” low short-term interest rates until the middle of 2013! This indicates that U.S. central bankers are unconvinced of the errors of their ways in their policy choices. That they are unwilling and unable to change course means that the U.S. and Japanese economies are doomed to painfully slow economic growth for the foreseeable future.

Christopher Lingle is visiting professor of economics at Universidad Francisco Marroquin in Guatemala and research fellow at the Centre for Civil Society in New Delhi.See All Posts by This Author

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