The End of QE?

The Fed’s quantitative easing program has been like that endless tub of popcorn or vat of soda that those with large appetites buy at the theater.  It goes on and on, but at some point, enough is enough.  Are you really ever going to refill that?

The Federal Reserve Board has gorged on bonds for years now and some board members are finally losing their appetite for continuing, according to minutes from the last meeting of the Federal Open Market Committee.

The supersized QE3, the third round of quantitative easing, was supposed to continue until the unemployment rate dropped to a reasonable number.  The only problem is that buying bonds doesn’t produce jobs.

Even accounting for Storm Sandy’s impact, job growth remains stalled, with the unemployment rate stuck at 7.8%.  While the rate is significantly lower than it was in 2009 (9.9%), it is nowhere near the 5.0% rate of 2007.  More troubling, much of the rate drop is due to people either dropping out of the workforce or taking low-paying part-time jobs.

That doesn’t mean that quantitative easing is without consequences.  The sudden nervousness of some Fed members reflects the fear that buying $85 billion in Treasuries and agency paper will destroy the dollar.

“When the flooding of markets with American debt causes the world to lose confidence in dollar-denominated securities, the nation will be in deep trouble,” George Melloan wrote in The Wall Street Journal.  “The only force standing in the way of that now is the Fed’s support of bond prices.  But regional Fed presidents are prudently asking how long that can be sustained.”

In spite of The Fed’s efforts to control interest rates and bond prices, Melloan cautioned, there are signs that interest rates may rise and bond prices may fall.  If that happens:

  • Government borrowing costs will rise.  In 2012, the U.S. paid nearly $360 billion in interest on its debt.  President Obama has said he wants to spend more, which would increase the debt.  If interest rates also increase, that $360 billion could easily hit $1 trillion, which will make it that much harder to try to control the deficit.
  • The Fed’s $2.6 trillion portfolio of bonds will decline in value, which, according to Melloan, could wipe out the Fed’s capital base and make it “a ward of the Treasury.”
  • Inflation will rise.  You may recall that the pre-Bernanke Fed did a pretty good job at keeping inflation in check.  The current Fed’s policies have been designed to keep deflation in check.  The only think that’s been holding back inflation has been the weak economy.

“Throughout history, governments have inflated away their debts by cheapening the currency,” Melloan wrote.  “That process is well under way through the Fed’s abdication to irresponsible government.  If Fed policies continue, another huge tax—inflation—will weigh down the American people.”

There was no quantitative easing program back in 2007 when the jobless rate was 5.0%.  Imagine that.

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