QE: Savior or Satan?
Though this be madness, yet there is method in’t.
– William Shakespeare, Hamlet Act 2, scene 2
Fed Chairman Ben Bernanke announced an exit strategy from the Fed’s unconventional monetary policy called quantitative easing (QE) last week.
Reaction was swift and unequivocal.
In two days time the markets lost 4%-5% of their total value. U.S. Treasury yields dramatically jumped +0.33% and are now over +0.5% just since June 6th! The day after the announcement had the rarest of occurrences – stocks and bonds were both being sold off at the same time!
It was as if investors no longer knew where to put their money, so took it out of everything.
It wasn’t a reaction to specific Fed actions. No. It was a knee-jerk reaction to what the Fed might do by mid-2014… end QE.
QE is either a stroke of genius or a tightrope to inevitable disaster. It hides a secret weapon.
As surprising as this sounds, that weapon may have already worked.
Public Purpose of QE
Everyone knows this old Keynesian storyline…
The defined purpose of QE is to pump liquidity back into an under performing economy. It re-balances capacity with production, thus growing the national economic engine back to full employment.
QE gets called into play when conventional policy – lowering the Fed’s prime interest rate – reaches the “zero lower bound” and breaks down.
Pure QE works through purchases of private-sector assets which are immediately converted into ready cash. That cash is supposed to be borrowed and spent. That, in turn, stokes job creation and revives the economy.
In one form or another The Fed has been doing QE since late 2008 during the collapse of the mortgage-housing bubble. Since then The Fed has pumped trillions of dollars into the economy through QE.
The fact is, by that definition, QE has failed.
The money created by The Fed is just sitting in T-bills. It is held as U.S. Treasury bonds that earn low, but steady, safe-haven profits for corporate America during economic uncertainty.
Maybe… just maybe… QE has another hidden, more important purpose – rebuild lost wealth.
QE’s Secret Weapon
Mortgage-backed securities!! QE is used to purchase mortgage-backed securities.
Wait? What? Isn’t buying and selling MBSs what brought down the economy in the first place?
Yes, it was.
So why, in the name of Satan’s lair, would The Fed do that again??
Ahhhhh… therein lies QE genius.
At the peak of the Great Recession home mortgages, the source of most ordinary American’s wealth, lost more than $16 trillion. No wonder nobody can afford anything. Where did all that wealth go?
Nowhere! The houses are still there. The buildings are still there. The property is still there. They still have all their intrinsic, physical value.
The money simply vanished! Poof! Gone! Adios, Amigo!
Here is where The Fed steps in. The so-called “free money” The Fed has been printing with QE is artificially raising mortgage values. The real wealth that should not have vanished, is being re-fabricated as synthetically as it disappeared during the Great Recession.
That is QE’s secret weapon.
Wall Street typically over-reacted to Fed Chairman Ben Bernanke’s remarks.
QE has been around for a long time. The thought of kicking that backstop out from behind corporate America triggered unreasonable chaos.
If you consider only it’s stated purpose, then QE has failed as monetary policy.
Consider, though, that it’s hidden purpose is to recreate all the lost “real” family wealth taken away from them during the Great Recession. It is doing that by buying mortgages with QE.
There is a problem. The Fed only buys mortgage-backed securities. That means it buys mortgages guaranteed through a federal program or a government sponsored enterprise (GSE).
Therefore, the federal government is creating money to buy something that it guarantees itself. That is like the tail wagging the dog. Ultimately, taxpayers are held accountable for mistakes.
Treasury bond yields have already spiked +0.33% in just three days. Low yields are the real key to economic recovery and controlling government’s ginormous debt. If those yields do not come back down and stay down for a long time, then all bets are off. The Fed will lose control of price stability.
It’s a dangerous game. Taxpayers could still be left stuck with the bill to pay the dinner tab.