The Effects of QE-Infinity

September 18, 2012

Among my predictions for 2012 (made in November of 2011) was the following (one of my “long-shot” predictions):

  • The Federal Reserve will implement yet another round of “quantitative easing.”  The Fed will issue to each bank a sum of money sufficient to pay down each home mortgage on its books by an amount of about $10,000, in effect paying off $10,000 worth of everyone’s mortgage.  The total program will amount to approximately$1 trillion in new, printed money.  The goal of the program will be to re-energize the housing market, essentially providing every homeowner with $10,000 of additional equity in their homes. 

On Wednesday of last week, the Federal Reserve did indeed announce a third round of quantitative easing, a program in which it will buy approximately $40 billion worth of mortgage backed securities every month from now on, until unemployment returns to a normal level.  While this isn’t exactly what I predicted – forking over $10,000 in printed money to every mortgage holder – the effect may ultimately prove to be about the same, boosting home valuations by that amount or more. 

While nobody – and I mean nobody, including the Federal Reserve – really understands the ultimate consequences of this move – I thought it’d be interesting to consider the possibilities.  This is a bit off-topic for this blog, but not entirely, since this move by the Fed will surely cause distortions in the economy (that much is certain) that will mask the effects of trade and population growth to which this blog is devoted.  With that said, the following are some possible consequences of “QE-Infinity,” a term I saw used in an article that I think more accurately captures the scope of this latest round of easing (money printing).

  1. The intent of this round of easing is to more directly impact the housing sector of the economy than previous rounds of easing have done.  In essence, this round of easing is an attempt to reinflate that bubble.  Will it work?  First of all, consider the impact on the market for mortgage backed securities.  Every month, between new and existing homes, approximately 5 million homes are sold in the U.S.  If you assume that, on average, each is financed by a mortgage of $150,000, then that’s a total of $750 billion in mortgages.  All of these mortgages are then bundled into “mortgage backed securities” and sold by the banks to anyone who will buy them, including foreign investors, flush with American trade dollars that they need to plow back into American assets.  So an extra $40 billion per month injected into that market isn’t a lot.  The Fed’s hope is two-fold:  that the additional money will then make it possible for the banks to loan more money and that the additional supply of mortgage funds will drive down interest rates.  Regarding the latter effect, I have my doubts.  With a greater demand for their mortgage backed securities, banks can lower the interest rates that they’ll have to pay on those securities, but what motivation is there for them to pass those savings on to their mortgage customers?  In all likelihood, those savings will go right to the bottom line of the banks.
  2. There is already no shortage of funds available for mortgages.  The banks are flush with cash, thanks in large part to the earlier rounds of Fed easing.  The problem with the housing market is that lending standards have tightened dramatically (as well they should have), pushing sub-prime borrowers out of the market.  Unless the Fed also exerts pressure on the banks to once again relax their lending standards, it’s difficult to see how this round of easing will translate into more lending. 
  3. With the Fed stepping into the mortgage backed securities market in a not-insignificant way, others will be effectively crowded out of that market and forced to invest their money elsewhere.  Treasuries?  Maybe.  But that bond market is already over-inflated.  The more likely candidate is the stock market, where valuations are currently reasonable and not over-inflated like the bond market.  An additional $40 billion a month poured into that market, over time, will tend to drive the stock market much higher, but eventually it too will become overinflated.  Then what?  Who knows?
  4. A higher stock market will certainly make people who own stocks feel wealthier.  That will translate into more consumer spending, some of which will be spent on housing, but some spent on manufactured goods, most of which are imported today.  So, expect some slight boost to jobs and downward pressure on unemployment, but also expect our trade deficit to worsen.  So any positive effect on our manufacturing sector will be offset by more intense competition from foreign manufacturers.  The net result is likely to be a weakening of our manufacturing sector – just the opposite of what the Fed would like to see.
  5. Eventually, that additional $40 billion per month will end up in Americans’ pockets.  (America is the only place where American dollars are legal tender.)  The question is which Americans – bankers or real walk-around people?  And will they spend it or save it? 
  6. If they do spend it, how long will it be before inflation begins to take off?  That’s always been the predicted effect of money printing – runaway inflation.  But it hasn’t happened yet (at least not “officially”), perhaps because the previous programs weren’t big enough and didn’t last long enough.  But this one is big and it will go on forever until one of two things happens – until unemployment comes down or until inflation takes off, thus triggering the Fed’s other mandate – fighting inflation.  There’s a risk here.  If the Fed doesn’t back off on this easing in the face of quickening inflation, it raises the spectre of hyperinflation like what happened in post-WWI Germany.  Investors might flee the market in droves.   
  7. This huge influx of money into the economy may make lawmakers feel more at ease when it comes to cutting the federal budget deficit.  If they do, then the federal government will effectively pull money out of the economy as fast as the Federal Reserve puts it in, and the effect will be zero.  (Although a reduction in deficit spending will tend to dry up the supply of treasuries, likely blowing the bubble in that market even bigger.)  

I can tell you this:  quantitative easing on a global scale (other central banks are doing it too) is powerless to reduce unemployment on a global scale in the long run, since worsening unemployment is driven by consumers’ growing inability to utilize products as over-crowding worsens.  Japan is living proof of this.  Their people consume little not because they lack money – they save tons of money – but because their crowded living conditions make it impossible to consume. 

But if people don’t consume, then inflation will never be a factor either.  Is it possible that all of this QE-Infinity money will do absolutely nothing other than make a very few people very, very rich?  I don’t know.  Neither does anyone else.  Anyone who says they do, including the most esteemed economists, are only guessing or wishing.  In the end, someone will prove to be right, but probably for all the wrong reasons. 

It saddens me to see this ever-greater reliance on money printing to prop up the economy, since it reduces the chances that anything will ever be done to address the root causes of our problems – trade imbalances driven by flawed trade theory and the destructive use of population growth to prop up macroeconomic growth.  In the meantime, distortions in the economy can only worsen.