On Wednesday, November 3rd, the Federal Reserve announced a well-anticipated, second round of quantitative easing (QE2), in the amount of $600 billion. The money will be used to purchase longer term treasury securities by the end of June 2011, at a pace of $75 billion per month. From their statement:
“To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.”
The stated purpose of this policy is that purchasing government bonds will help lower long term interest rates, spur spending, and decrease unemployment. It will also prevent deflation and ensure a healthy level of inflation, which the central bank stated as its mandate for the first time ever this year. Chairman Bernanke even went so far as to suggest that what essentially amounts to a stock market bubble is the way to recovery in a recent op-ed for the Washington Post:
“…lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
Either they have no understanding of basic economics or they have ulterior motives for following such a destructive policy. Obviously it is the latter: with over $120 trillion in obligations, the government has a major incentive to devalue the currency, which is a hidden method of defaulting.
This attempt to artificially lower interest rates further, which has already been suppressed as much as possible through traditional means, will cause further malinvestments. Interest rates are the price of money, and they coordinate the supply of and demand for savings. To tamper with that price and artificially lower it will send false signals that there are savings than actually exist. Investments will follow the misleading signals; in the meantime, savings will be discouraged by low interest rates. It ultimately ends up as a bubble that bursts, leaving the economy in worse shape than before.
It should be clear enough that the false prosperity created in these artificially induced booms is not the path to prosperity- even though it bring temporary increases in spending and employment. It’s no surprise they want to pursue this policy, though: a shortcut always sells better to voters. And paying off debt with diluted money is much easier than admitting it can’t be paid in full.
Real economic recovery will happen once impediments to savings and business are reduced; not by toying around with monetary policy- which amounts to playing with fire in our economic drought.