QE2: Last Rites for the World’s “Reserve Currency”
November 8, 2010
Millions of Americans have no idea what Quantitative Easing is or how it will effect them personally. That’s why Wednesday’s announcement that the Fed will purchase another $600 billion in US Treasuries merely reinforced feelings of helplessness and a sense that government spending is out-of-control. Unfortunately, Ben Bernanke’s rambling explanation of QE2 in a Washington Post op-ed on Thursday only added to the confusion. The article is loaded with half-truths and omissions that are meant to mislead the public about how the program works and what the Fed’s real objectives are. It’s another missed opportunity by Bernanke to come clean with the people and let them know what policies are being enacted in their name. Here’s an excerpt from the article:
“The Federal Reserve’s objectives — are to promote a high level of employment and low, stable inflation. Unfortunately, the job market remains quite weak; the national unemployment rate is nearly 10 percent, a large number of people can find only part-time work, and a substantial fraction of the unemployed have been out of work six months or longer. The heavy costs of unemployment include intense strains on family finances, more foreclosures and the loss of job skills…..Low and falling inflation indicate that the economy has considerable spare capacity, implying that there is scope for monetary policy to support further gains in employment without risking economic overheating. The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed…..the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability. Steps taken this week should help us fulfill that obligation.”
Bernanke mentions employment/unemployment 5 times in the first 3 paragraphs to give the impression that QE is about creating new jobs. But everyone knows that’s baloney. If Bernanke was really worried about jobs, he would have appealed to Congress for a second round of fiscal stimulus in his speech, which he didn’t, because he remains hawkish on deficits like his colleagues in the GOP-led congress.
Also, if QE2 is mainly about jobs, than why not settle on benchmarks to determine whether the program is successful or not? In other words, if unemployment is still hovering at 8 or 9% in June 2011, when the program ends, then we can assume that Bernanke was either wrong in his calculations or deliberately misled the public about what the program really does.
The truth is, Quantitative Easing will not reduce unemployment, narrow the output gap, or increase aggregate demand. At best, it will lower long-term interest rates (slightly) and buoy asset prices. That may be good for the stock market, but it won’t lay the groundwork for a strong recovery. In fact, it might not even be enough to keep the economy from slipping back into recession. As last Friday’s report from he Bureau of Economic Analysis indicates, most of 3rd Quarter GDP was from rebuilding inventories. Remove inventory restocking, and final demand was a sickly 0.6%. So, how will Bernanke’s bond purchasing program increase final demand?
It won’t. If the Fed buys Treasuries, Treasury yields go down which pushes investors into riskier assets (like stocks). That pushes stocks higher, investors feel richer, spending takes off, businesses hire more workers, and the economy grows. It’s a great theory, but it doesn’t work. Yields are already at record lows and businesses are still not hiring because there’s no demand for their products. The problem cannot be fixed from the supply side, which is to say, that it doesn’t matter how cheap money is, if no one is borrowing. And no one is borrowing because they are either broke or out-of-work. Bernanke’s grand plan doesn’t get money to the people who need it, so the economy will continue to sputter.
Also, Yields on the 10-year and 30-year Treasuries have already dipped in anticipation of QE2, but is there any sign that businesses are planning to start hiring again? Of course not, because low interest rates don’t matter in this environment. Case in point; record-low interest rates haven’t increased home sales at all. Cheap money doesn’t generate demand when personal balance sheets are underwater. Bernanke knows this because he’s studied Japan’s Lost Decade and understands what happened. They initiated two massive QE programs and got zippo—bank loans and credit continued to go sideways. So, Bernanke is being disingenuous. But why?
The reason is that the Fed is locked in a violent exchange-rate war to push down the value of the dollar. Bernanke wants to trim the current account deficit to boost exports. But he’d rather not tell the American people that he’s using their currency as a bludgeon to beat trading partners into submission. It’s easier just to scribble some gibberish about “generating jobs” and send it off to the Washington Post.
The Fed is at war; that’s the truth of the matter. Economist Michael Hudson calls Quantitative Easing (QE) “a form of financial aggression.” But Hudson probably understates the case; “monetary terrorism” (moneterrorism?) is probably closer to the truth. QE is flooding emerging markets with cheap capital that’s forcing their leaders to take defensive action to protect their economies. EM’s have already seen the first wave of liquidity surge into their markets raising havoc with prices and forcing central banks to raise rates. But emerging markets aren’t taking it laying down. They’re throwing up protectionist barriers and monitoring capital flows. If Bernanke’s going to print more money, they’ll print, too. Mass competitive devaluation will ignite a full-blown currency war that leaves the present trade regime in tatters and the dollar in the dustbin.
This is from Richard Portes in an article titled “Currency wars and the emerging-market countries”:
“If the large developed market countries do more QE, however, then the flow of liquidity to the emerging markets may force the latter to respond. They may try to resist exchange-rate appreciation by intervening in the foreign exchange markets. Here we do have competitive devaluation – the “currency wars”….
This is why we see statements like “The US will win this war: it will either inflate the rest of the world or force their exchange rates up against the dollar” (Wolf 2010). But there is a potential downside for the US. Substantial dollar depreciation will weaken the global position of the dollar, as it did in the late 1970s. (Chinn and Frankel 2007)
The Fed will proceed with QE. It will not accept foreign constraints on its monetary policy, nor will it run an internationally “coordinated” or “cooperative” monetary policy.” (“Currency wars and the emerging-market countries”, Richard Portes, VOX)
See? This isn’t about jobs at all. It’s about power. It’s about who is going to dictate policy to the rest of the world. Bernanke wants emerging markets to bear the costs of a financial crisis that originated on Wall Street and was nurtured every step of the way by the easy money policies of the Federal Reserve. Rather than accept responsibility for his actions–by restructuring the banking system and forcing them to write down their debts– Bernanke has decided to create inflation by opening the sluice-gates and releasing a wall of liquidity that will (inevitably) produce asset bubbles and turmoil in foreign markets. The plan will put the dollar under severe pressure and could trigger a flight from dollar-backed assets, particularly US Treasuries. That would spark the Doomsday Scenario; a disorderly unwinding of the dollar and a swift plunge into crisis. That possibility is not as remote as many think. Here’s a clip from the UK Telegraph’s Ambrose-Evans Pritchard:
“The Fed’s “QE2″ risks accelerating the demise of the dollar-based currency system… a chorus of Chinese officials and advisers is demanding that China switch reserves into gold or forms of oil. As this anti-dollar revolt gathers momentum worldwide, the US risks losing its “exorbitant privilege” of currency hegemony.” (QE risks currency wars and the end of dollar hegemony, Ambrose-Evans Pritchard, Telegraph)
Or, this from Nobel prize winner, Joseph Stiglitz:
“The world is on the verge of moving to another regime of managed exchange rates and fragmented capital markets….A new global reserve system or an expansion of IMF “money” (called special drawing rights, or SDRs) will be central to this co-operative approach. With such a system, poor countries would no longer need to put aside hundreds of billions of dollars to protect themselves from global volatility, and these would add to global aggregate demand…. with such a system, the US would no longer enjoy the extraordinarily cheap borrowing that comes with being the minter of the most important global reserve currency. But the current arrangement is an anomaly. The world is at a critical juncture.” (A currency war has no winners, Joseph Stiglitz, The Guardian)
Or this from economist Michael Hudson who believes that the rising powers Brazil, Russia, India and China (BRIC) will challenge the current dollar-dominated regime leading the way to a new multi-polar world order. Here’s what he says:
“The most decisive counter-strategy to U.S. QE II policy is to create a full-fledged BRIC-centered currency bloc that would minimize use of the dollar….A BRIC-centered system would reverse the policy of open and unprotected capital markets put in place after World War II. … In September, China supported a Russian proposal to start direct trading using the yuan and the ruble rather than pricing their trade or taking payment in U.S. dollars or other foreign currencies. China then negotiated a similar deal with Brazil. And on the eve of the IMF meetings in Washington on Friday, Premier Wen stopped off in Istanbul to reach agreement with Turkish Prime Minister Erdogan to use their own currencies in a planned tripling Turkish-Chinese trade to $50 billion over the next five years, effectively excluding the dollar.”
It won’t happen overnight, but the transition away from the dollar has already begun. The financial crisis has greatly eroded US moral authority and the trust that’s needed to preserve America’s role as the steward of the world’s reserve currency. Bernanke’s misguided hyper-monetarism is merely hastening the dollar’s decline. QE2 could very well be the straw that breaks the camel’s back.
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