The Fed's Last Bullet

10/27/2010 12:00 pm EST


John Mauldin

Chairman, Mauldin Economics

John Mauldin, editor of Thoughts from the Frontline, says the Fed has its back against the wall, and there’s no guarantee further “quantitative easing” will actually stimulate the economy.

The Federal Reserve is basically down to one bullet in its policy gun. It cannot lower rates beyond zero, although it can pull down longer-term rates if it so chooses. But lower rates so far have not been the answer to creating jobs and inflation. All less-subtle instruments of monetary policy have been tried.

The final option is massive quantitative easing, the monetization of US government debt. As the saying goes, if all you have is a hammer, all the world looks like a nail.

The Keynesian cowboys are saddling their QE horses, and they intend to ride. They have no idea what the end result will be. This is all a guess based on pure theory and models (like the broken money multiplier). And I really question whether the result they hope for is worth the risk of the unintended consequences.

Former Fed governor Larry Meyer, according to Morgan Stanley, “… estimates that a $2-trillion asset purchase program would: 1. lower Treasury yields by 50 [basis points]; 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.'”

If the economy continues to sputter and looks like it may fall into recession, the need to do something will overwhelm all caution.

Is there a chance that it could work? The short answer is, "yes, but I doubt it." The whole purpose of QE2 is to get consumers and businesses spending. For a Keynesian, it is all about stimulating final consumer demand. That is tough in a world coming out of a credit crisis, where consumers are wanting to deleverage.

It is doubtful that any QE2 that is enough to really do something in the way of reflating assets will be good for the dollar. Now, cynics might say that is the point, as a falling dollar is supposed to help our exports. Do we really want to open the first salvo in a race to the currency bottom?

But QE2 also drives up commodity costs. Rising oil prices have the same effect on spending as a tax increase. As do rising food costs, etc.

Does the Fed really want us to get our animal spirits back up and go back in and borrow more money? Isn't too much leverage what got us into this problem to begin with? Should we buy stocks now in hopes that QE2 somehow keeps us from recession? If it doesn't work, then all those buyers will get their heads handed to them, making matters even worse.

We do not have a monetary problem. And whatever solutions we need are not monetary. This is on Congress and the

Administration. The Fed needs to step aside.

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