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Making sense of another round of quantitative easing

QE3 raises at least as many questions as it answers. 

We can guess that by the time the Fed stops the total amount of money printed will be around $2T.

What’s a few more billion dollars a month in today’s money?  On Thursday, the Federal Reserve announced that they were going to purchase $40B more mortgage backed securities every month, a total of $85B, with money they more or less print themselves.  It’s the third round of Quantitative Easing, or QE3, but this time they left the dollar amount open ended.  We can guess that by the time they stop the total amount printed will be around $2T.  That’s more like the insane numbers we’ve gotten used to the last four years.

They are doing this because unemployment remains stubbornly high in a weak economy.  Why they picked mortgages and what affect it will really have is another long story, but the bottom line is that election year or not the Fed is on the case and doing whatever it can.  But is it too much?  And what comes after all this money is printed?  There are a lot of questions.  Let’s work our way through them.

Let’s start with the theory. Right now the Fed is the largest buyer of mortgages, picking them up as bundles being serviced through other private agencies.  They appear to have picked this because it is the fastest way to get money out into the general economy – something that previous QEs failed to do.  A 30 year mortgage is already at an all-time low, 3.6% fixed, but by driving it down more there should be more money in consumers’ pockets, a rise in home prices, more construction, and generally good feelings.  Given that it takes months to refinance or apply for a mortgage, however, this won’t work its magic right away.

Where this gets interesting is in how totally unprecedented the action is.  The Fed never felt responsible for taking care of employment before.  It certainly never bought mortgage backed securities like this either.  And traditionally it takes no action two months before an election, trying desperately to stay out of the news.  This is an activist Fed, ready to strike at the first sign of weakening to prop things up.  The signal to move was apparently that weak jobs report from August, meaning that they believe the Department of Labor numbers.

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If this sounds like panic to you, welcome to the club.

One of the biggest immediate problems is that intervention before the election has the Republicans riled up.  They see Bernanke’s move as a corrupt attempt to use the Fed to boost things before November.  Support for this action is falling strongly along partisan lines, a political worst-case scenario for the Fed.

The other problem that will have to be dealt with is that this kind of money has to eventually become inflationary.  More money chasing the same number of goods means the money is worth less, so it takes more of it.  As long as the velocity of money stays low, as it has for years, but at the first sign of recovery we can expect inflation.  Then again, serious inflation is the easiest way to make our debt much more manageable, paying it all off in the future with much cheaper money.  Is it all part of a big plan?  How does that fit with the European action to do more or less the same thing?

The value of the US Dollar is already dropping against all currencies, which is a good thing for our manufacturing sector.  But it means that the price of oil is likely to head back over $100 per barrel (West Texas Intermediate), putting immediate pressure on inflation.  The Fed knew this, of course, and started its press release by saying that prices have been very stable – that is, there is room for a little more inflation.  Expect $4 at the gas pumps shortly.

But what really happens when we have to reel this $2T in money printed through three rounds of Quantitative Easing?  As the global standard “reserve currency”, US Dollars show up all over the planet.  It’s been estimated that 2/3 to 3/4 of all printed money is overseas now.  If inflation runs away and we start to wish we never printed all this, how do we cal lit back?  What happens when a nation completely loses control of its own currency?  That is the 2-trillion dollar question!

Meanwhile, the economy is weak and the US Government has not sorted out its own finances, facing another crisis by December.  That’s part of what the Fed is preparing for in this round.  But the long term problems are breathtaking, leaving aside whatever value is really held by all these mortgages the Fed is buying.  And, of course, we’re missing yet another opportunity to push the reset button on the whole economy through “Jubilee“.

QE3 raises at least as many questions as it answers. We’ll have to stay tuned to find out what happens.

This post was written by Erik Hare and originally published on Barataria. Follow Erik on Twitter: @wabbitoid. 

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