Quantitative Easing: To Infinity And Beyond

Since the Great Recession started a couple years ago*, the federal reserve has been involved in a process called "Quantitative Easing".  I've discussed this before so I won't go into the process any further.  The second round of Quantitative Easing, QE2, is set to expire at the end of June.  Watch the talking heads on TV and they'll tell you, almost unanimously, that there will be no further rounds of QE.  Their reasoning is that the economy is turning around.  I think the economy only appears to be turning around because of the QE, and the recovery isn't sustainable without it. Either my laymen understanding of our economic condition is terribly wrong, or these guys are grossly stupid.  I have a very healthy ego so I'm going to go with the latter.  Here's why I think that QE3, QE4, QE5, etc will happen.

As I mentioned in the article I linked above, the federal government is running huge deficits, and will be doing so for at least the next decade.  This means that the treasury has to sell bonds to cover the budget deficits.  Since QE2, the federal reserve has been buying 70% of new treasury bonds.  When QE2 ends, and the fed stops buying treasuries, someone has to pick up the slack.  And that's a lot of slack.

You might be thinking that China will come to the rescue again, but I don't think they can continue to do that.  When they buy our treasuries, they have to print money to do so, which causes inflation.  They're already experiencing a high level of inflation, possibly as much as 10% or more.  They're currently importing much of our inflation in order to keep their currency pegged to our dollar.  But the inflation problem in China (and all over the world really) is leading to some civil unrest that The State needs to avoid.  As we've recently seen in the Middle East, citizens will put up with brutal regimes as long as they have a job and can afford food.  By printing money, we're pushing up the price of food all over the world, China included.**  In order to get their inflation under control and calm the citizenry, China is going to have to stop buying our debt with money they print.

So if not China, then who?  That's a very good question.  A better question might be How much interest are these unknown buyers going to charge?  Since the fed represents 70% of bond demand, once they quit buying bonds the demand will drop and interest rates will surge.  If interest rates go up significantly, the federal government is going to have to find more buyers of our debt to cover the higher amount in interest payments plus the new debt we take on.  Finding more buyers of this debt in a market where demand is low will push interest rates up higher, which will cause us to have to find even more buyers who will demand higher interest which will cause us to find even more buyers which will... well, you get the idea.  It's called a Ponzi Scheme, and even Bernie Madoff recognizes that our entire government operates as one.  If there are no buyers of our debt other than the federal reserve, the federal reserve will be forced into filling that gap in order to keep interest rates low.

Another problem is that the economy cannot sustain the "growth" we've experience over the past 6 months or so without the money that the fed is providing through QE2.  On average, the federal reserve has been purchasing 5-8 billion dollars of treasuries a day and injecting that new money into the system.  This has been great news for stocks since the vast majority of that money makes its way to the big guys on Wall Street.  Ever since "Jackson Hole" late last August, when the fed announced their plan for QE2, stocks have almost gone straight up***.  Before that, the economy was in shambles in the vacuum left behind after QE1.  Things aren't much different now than they were last summer.  Many of our problems have not been fixed and most of the ones that matter are even worse today.  Once the fed stops pumping money into the economy, the "recovery" will sputter and there will be a lot of pressure on them to fire up the printing press.

There is a problem though.  The public is becoming more and more nervous about all of the money printing.  Luckily for Washington, the public is also easily manipulated.  If QE3 happ When QE3 happens, they can do it without calling it that officially.  QE2 is written in such a way that it can be expanded upon if the fed chooses to do so.  That means that we do another round of Quantitative Easing but call it a continuation of QE2, or some other goofy name altogether.  It will also be interesting to see what tragedy or crisis they say we are on the brink of in order to convince the public that it is necessary.  I'm of the mindset that we're already on the brink of an economic depression if we stop the QE(insert number).  But as I've said before, that is an inevitability that is only being delayed and intensified by the actions of the federal reserve.  If we continue on this QE/huge deficit spending path, we're almost guaranteeing that we experience hyperinflation and a total economic collapse. The sooner we try to deal with the mess in a real and honest way, the better.  2008 would have been a nice time to start...



*Fun fact: The Great Recession officially ended in September 2010. That's according to Government Data though.  Mark Twain popularized the phrase "There are lies, damned lies, and statistics."  Today that phrase would be "There are lies, damned lies, statistics, and government statistics."

**Because we have the world's reserve currency, food is traded in US dollars in the world markets.  When we print 2 trillion dollars to prop up our economy, we also bring the price of food up across the world.  These Mid-East protests can be directly linked to our inflationary monetary policy.  If it spreads to Saudi Arabia, I hope you can afford $5(probably even more) gas

*** This chart shows the DOW from a couple weeks before the announcement of QE2 (end of August) until now.  Stocks were falling until the minute QE2 was announced.  Wall Street loves free money from the fed.