6 Sep 2011

Is QE3 Right Around the Corner?

Is QE3 Right Around the Corner?
At the recent Jackson Hole symposium, Ben Bernanke effectively made a play for time. He didn’t announce any new policy measures, but he did leave the door open for more quantitative easing, by stating that the Federal Reserve was ready to take necessary measures to help the economy. Bernanke was probably hoping for more time to wrestle with economic news, since the FOMC’s next two-day meeting isn’t until September 20 and 21, 2011.
With the latest employment figures, though, more analysts, investors, pundits and economists are wondering if another round of quantitative easing could be around the corner. U.S. economic news continues to point to the possibility of a double-dip recession, and the news that no net jobs were created in August 2011 is just another bit of disappointing economic news for Fed monetary policy makers to chew on. So, is QE3 right around the corner?

What is Quantitative Easing?

The point of quantitative easing is to stimulate the economy after more conventional attempts have failed. In the U.S., the Federal Reserve attempts to stimulate the economy by implementing measures that lower the Fed Funds Rate so that banks can lend to each other at lower rates, hopefully spurring them to lend to consumers at lower rates as well, and increasing demand for consumer loans that can fuel consumer spending – which accounts for around 2/3 of our country’s economic activity.
Right now, though, short-term interest rates are quite close to zero. Central banks might try buying short-term government bonds to lower market rates, but when you are this close to zero, it’s hard to lower rate further. This is where quantitative easing comes in. The idea is to purchase longer-term government bonds, as well as purchase financial assets from private sector businesses, including banks. This is done with money that is essentially created out of thin air. Our digital financial system offers the ultimate fiat money, money that is exists because the Fed says it exists. The hope is that the new, electronically created money will increase the money supply, and increase the money moving around in the system, stimulating the economy so that it grows.
Since the financial collapse of 2008, we have seen two rounds of quantitative easing. The latest round of quantitative easing, QE2, lasted from November 2010 to June 2011. According to the Financial Post, QE2 was considered something of a success, and it’s perceived success might be an impetus for the Fed to announce QE3 later this month:
“More importantly, QE2 was successful in ‘propping up’ the equity markets and creating what pundits term as the ‘wealth-effect.’ This means a belief that a strong performing stock market results in greater overall consumer confidence and an increase in spending. Therefore, the current market sell off since May of this year may be enough of a motivating factor for QE3 not unlike what transpired during the sell off preceding the announcement of QE2 in the summer of 2010.”
It will be interesting to see what happens next. According to Forbes, well-known “Dr. Doom” economist Nouriel Roubini feels that QE3 is coming (although he thinks it will be too little, too late) – along with QE4 and QE5.

What Quantitative Easing Could Mean for Savers

One of the points of quantitative easing is to help stimulate the economy – and that usually means some sort of inflation. In order to continue economic growth, many central banks, including the Federal Reserve, pay attention to inflation and attempt to keep it in a certain range. During times of recession, inflation is usually low, so stimulus is meant to help push inflation up a bit. Where quantitative easing can backfire is if the attempts actually push inflation higher than planned for. (Another issue is if the attempt doesn’t work effectively enough to encourage more lending/borrowing.)
For savers, more quantitative easing means more low yields – and no end in sight. And, of course, it means that savers run the risk of not being able to receive yields that beat inflation. This leads to losses in real terms, even if you have cash and other relatively safe investments. (The Forbes article points out, too, that there might come a point when the Fed tries to arrange policy so that Treasury yields are all the way down to 1.5%.)
It is worth noting, too, that even inflation protected Treasury investments might not help you during times like these. There is a debate over the accuracy of CPI as a measure of inflation for “real” people in real world scenarios. Some think that the true cost of inflation on Main Street is much higher than the “official” measures would have us think. Indeed, some argue that there is plenty of inflation going on right now, and that QE3 will only mean an “inflation tax.” Others contend that QE3 could also lead to asset bubbles, further destabilizing markets, and putting the economy at greater risk of instability.
In the long term, though, some argue that QE3 will be of benefit. If quantitative easing efforts ultimately work, the economy should recover, and yields on cash products should rise again, to a point where they will once again be of true benefit to savers. Some recommend that savers look for one year and two year CD rates that are reasonably high now, but provide a way to roll the CDs over into longer term products in a couple years when the economy is on the right track and yields are higher. (Of course, this scenario assumes that economic recovery will come in the next couple of years.) For now, though, and as has been happening since attempts at economic stimulus beginning in 2008, savers are likely to continue to see the short end of the stick. QE3 likely won’t change that.
What do you think of quantitative easing?

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