The Fed's Next Spending Spree

09/30/2010 1:00 pm EST


John Mauldin

Chairman, Mauldin Economics

John Mauldin, editor of Thoughts from the Frontline, says the central bank is considering another round of “quantitative easing” to boost the economy, but he doubts it will work.

The Federal Reserve seems to be setting us up for another round of quantitative easing (QE). That is Fed speak for buying a few trillion dollars of government debt and injecting said cash into the economy.

The question is whether a few trillion dollars spent purchasing government debt would do the trick.

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.

[But] if banks are not lending now with what seems like lots of reserves, then [why will] another $2 trillion in QE make them feel like they have too much money in their vaults?

How much of an impact would $2 trillion in QE give us? Not much, according to former Fed governor Larry Meyer, who estimates that a $2-trillion asset purchase program would: 1. lower Treasury yields by 50 basis points (0.5%); 2. increase [gross domestic product] growth by 0.3 percentage points in 2011 and 0.4 percentage points in 2012, and 3. lower the unemployment rate by 0.3 [percentage points] by the end of 2011 and 0.5 [percentage points] by the end of 2012. However, Meyer admits that these may be “high-end estimates.”

That 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.

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.)

If the economy is recovering, QE is not needed. Note that the US economy in the current quarter may be doing better than last. Perhaps we have turned the corner. Again, the banks have plenty of reserves, so another $2 trillion is not needed.

But what if they went ahead and threw $1 trillion to $2 trillion against the wall? If it showed up back at the Federal Reserve, it would only [reveal] that the Fed does not have the tools it needs, or would have to be really willing to monetize debt. It would be Keynes’s "liquidity trap" or what Fisher called debt deflation. Neither is good.

That's called pushing on a string. If the markets sensed that, it would not be pretty.

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