The United States economy
could use a good dose of "aggregate demand" - new
spending money in the pockets of consumers - but a
third round of quantitative easing (QE3) by the
Federal Reserve won't do it. Neither will it
trigger the dreaded hyperinflation. In fact, it
won't do much at all. There are better
alternatives.
The Fed's announcement on
September 13 that it was embarking on a third
round of quantitative easing has brought the
"sound money" crew out in force, pumping out
articles with frightening titles such as "QE3 Will
Unleash' Economic Horror' On The Human Race". [1]
The Fed calls QE an asset swap, swapping
Fed-created dollars for other assets on the banks'
balance sheets. Critics call it "reckless money
printing" and say it will
inevitably produce
hyperinflation. Too much money will be chasing too
few goods, forcing prices up and the value of the
dollar down.
All this hyperventilating
could have been avoided by taking a closer look at
how QE works. The money created by the Fed will go
straight into bank reserve accounts, and banks
can't lend their reserves. The money just sits
there, drawing a bit of interest. The Fed's plan
is to buy mortgage-backed securities (MBS) from
the banks, but according to the Washington Post,
this is not expected to be of much help to
homeowners either. [2]
Why QE3 won't
expand the circulating money supply In its
third round of QE, the Fed says it will buy US$40
billion in MBS every month for an indefinite
period. To do this, it will essentially create
money from nothing, paying for its purchases by
crediting the reserve accounts of the banks from
which it buys them. The banks will get the dollars
and the Fed will get the MBS. But the banks'
balance sheets will remain the same, and the
circulating money supply will remain the same.
When the Fed engages in QE, it takes away
something on the asset side of the bank's balance
sheet (government securities or mortgage-backed
securities) and replaces it with
electronically-generated dollars. These dollars
are held in the banks' reserve accounts at the
Fed.
They are "excess reserves", which
cannot be spent or lent into the economy by the
banks. They can only be lent to other banks that
need reserves, or be used to obtain other assets
(new loans, bonds, etc). As Australian economist
Steve Keen explains:
[R]eserves are there for settlement
of accounts between banks, and for the
government's interface with the private banking
sector, but not for lending from. Banks
themselves may ... swap those assets for other
forms of assets that are income-yielding, but
they are not able to lend from them. [3]
This was also explained by Professor
Scott Fullwiler, when he argued a year ago for
another form of QE - the minting of some trillion
dollar coins by the Treasury (he called it "QE3
Treasury Style" [4] He explained why the increase
in reserve balances in QE is not inflationary:
Banks can't "do" anything with all
the extra reserve balances. Loans create
deposits - reserve balances don't finance
lending or add any "fuel" to the economy. Banks
don't lend reserve balances except in the
federal funds market, and in that case the Fed
always provides sufficient quantities to keep
the federal funds rate at its ... interest rate
target. Widespread belief that reserve balances
add "fuel" to bank lending is flawed, as I
explained here
over two years ago.
Since November
2008, when QE1 was first implemented, the monetary
base (money created by the Fed and the government)
has indeed gone up. But the circulating money
supply, M2, has not increased any faster than in
the previous decade, and loans have actually gone
down. [5]
Quantitative easing
has had beneficial effects on the stock market,
but these have been temporary and are evidently
psychological: people THINK the money supply will
inflate, providing more money to invest, inflating
stock prices, so investors jump in and buy. The
psychological effect eventually wears off,
requiring a new round of QE to keep the game
going. That is what happened with QE1 and QE2.
They did not reduce unemployment, the alleged
target; but they also did not drive up the overall
price level. The rate of price inflation has
actually been lower after QE than before the
program began. [6]
Why is the Fed engaging in
QE3? If the Fed is doing no more than
swapping bank assets, what is the point of this
whole exercise? The Fed's professed justification
is that by buying mortgage-backed securities, it
will lower interest rates for homeowners and other
long-term buyers. As explained in Reuters:
Massive buying of any asset tends to
push up the prices, and because of the way the
bond market works, rising prices force yields
[or interest rates] down. Because the Fed is
buying mortgage-backed bonds, the purchases act
to directly lower the cost of borrowing to buy a
home.
In addition, some investors, put
off by the rising price of the bonds that the
Fed is buying, turn to other assets, like
corporate bonds - which, in turn, pushes up
corporate bond prices and lowers those yields,
making it cheaper for companies to borrow - and
spend. [7]
Those are the professed
objectives, but politics may also play a role. QE
drives up the stock market in anticipation of an
increase in the amount of money available to
invest, a good political move before an election.
Commodities (oil, food and precious
metals) also go up, since "hot money" floods into
them. Again, this is evidently because investors
EXPECT inflation to drive commodities up, and
because lowered interest rates on other
investments prompt investors to look elsewhere.
There is also evidence that commodities are going
up because some major market players are colluding
to manipulate the price, a criminal enterprise.
[8]
The Fed does bear some responsibility
for the rise in commodity prices, since it has
created an expectation of inflation with QE, and
it has kept interest rates low. But the price rise
has not been from flooding the economy with money.
If dollars were flooding economy, housing and
wages (the largest components of the price level)
would have shot up as well. But they have remained
low, and overall price increases have remained
within the Fed's 2% target range. (See chart
above.)
Some more effective stimulus
possibilities An injection of money into
the pockets of consumers would actually be good
for the economy, but QE3 won't do it. The Fed
could give production and employment a bigger
boost by using its lender-of-last-resort status in
more direct ways than the current version of QE.
It could make the very-low-interest loans
given to banks available to state and municipal
governments, or to students, or to homeowners. It
could rip up the $1.7 trillion in government
securities that it already holds, lowering the
national debt by that amount (as suggested a year
ago by Ron Paul [9] Or it could buy up a trillion
dollars' worth of securitized student debt and rip
those securities up. These moves might require
some tweaking of the Federal Reserve Act, but
congress has done it before to serve the banks.
Another possibility would be the sort of
"quantitative easing" first proposed by Ben
Bernanke in 2002, before he was chairman of the
Fed - just drop hundred dollar bills from
helicopters. (This is roughly similar to the
Social Credit solution proposed by C H Douglas in
the 1920s.) As Martin Hutchinson observed in Money
Morning:
With a US population of 310 million,
$31 billion per month, dropped from helicopters,
would have given every American man, woman and
child an extra crisp new $100 bill per month.
Yes, it would produce an extra $31
billion per month on the nominal Federal budget
deficit, but the Fed would have printed the new
bills, so there would have been no additional
strain on the nation's finances.
It
would be much better than a new social program,
because there would have been no bureaucracy
involved, just bill printing and helicopter
fuel.
The money would nearly all have
been spent, increasing consumption by perhaps
$300 billion annually, creating perhaps 3
million jobs, and reducing unemployment by
almost 2%. [10]
None of these moves
would drive the economy into hyperinflation.
According to the Fed's figures, as of July 2010,
the money supply was actually $4 trillion LESS
than it was in 2008. [11] That means that as of
that date, $4 trillion more needed to be pumped
into the money supply just to get the economy back
to where it was before the banking crisis hit.
As the psychological boost from QE3 wears
off and the "fiscal cliff" looms, perhaps congress
and the Fed will consider some of these more
direct approaches to relieving the economy's
intractable doldrums.
Ellen Brown is an attorney and
president of the Public Banking Institute, PublicBankingInstitute.org.
In Web of Debt, her latest of 12 books, she
shows how a private cartel has usurped the power
to create money from the people themselves, and
how we the people can get it back. Her websites
are webofdebt.com and
ellenbrown.com.
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