Dangerous consequences of quantitative easing

Knoxville News-Sentinel March 3, 2013 Increased deficits lead to increased debt. If financed by the Federal Reserve, it leads to increased money supply, a fall in bond interest rates, cheaper debt, decreased value of the dollar, currency wars, trade barriers, recession, increased inflationary fears, asset bubbles, recession. Simple isn’t it? The Federal Reserve through its QE1, QE2 and QE Infinity has given the federal government an unlimited budget. The government is politically constrained in its ability to raise taxes to finance its irresponsible deficits and is also limited in its sales of Treasury securities to the public. Sooner or later the public has enough Treasuries in its portfolios. However, the Fed has purchased $3 trillion of government securities, allowing the government to keep spending. Thus, the deficit continues to grow as well as the national debt. Moreover, the increased buying of securities causes their prices to rise and their yields to fall as well as increases the money supply. There are several consequences to this action. The first is truly ironic. With the rates on Treasuries low, the cost of borrowing by the government is low as well. This leads to the absurdity that the president can claim in the State of the Union address that there is $500 billion in interest savings, which leads to deficit reduction! Yes. He is saying that an increase in the deficit leads to a decrease in the deficit. The Fed’s policy of quantitative easing by increasing the supply of dollars results in a fall in its value. As the U.S. debt has grown the value of the dollar has shrunk. This is a key point: As a country’s debt increases, devaluation of its currency becomes more attractive because it makes its debt cheaper to service. Not surprisingly, governments throughout the world were not pleased. The Brazilian finance minister accused the U.S. of engaging in unfair trade practices since Brazilian exports to the U.S. were made more expensive and U.S. imports to Brazil cheaper. Of course he was right. Indeed, some have said that the Fed’s actions deliberately were intended to boost U.S. exports and decrease imports in an effort to lessen the impact of the recession on the U.S. Other governments, in particular Japan, have devalued their currencies also in efforts to try to spur growth. It is no coincidence that Japan’s debt is over 230 percent of its gross domestic product. This has led to a concern of “currency wars” as countries seek to protect themselves from adverse moves in their trading partners’ currencies. One real danger is that currency wars have in the past triggered trade protection measures that have led to global recessions. Another real danger is the creation of asset bubbles. Right now, as investors move away from low yielding financial assets and seek protection from the inflationary pressures of increased money supplies, the prices of real assets begin to rise. Thus, the stage is set for another bursting of asset bubbles leading to yet another severe recession. Although Fed chairman Ben Bernanke’s term as chairman of the Fed ends in a couple of years, there is no solace in knowing that his likely successor is vice chair Janet Yellen, who said in a recent speech that the Fed’s actions are “a policy that is not only good for output and employment and American workers, but also for the federal finances overall.” Heaven help us all. Get Copyright Permissions © 2013, Knoxville News Sentinel Co.