Trepidation About Quantitative Easing

[RedEarth]

Trepidation About Quantitative Easing, Version 2.0


The Fed made official its move to quantitative easing today, and said it will take no prisoners until it has lowered rates and credit spreads further:

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability...

The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

I (literally) have a very bad feeling in my stomach. This move is a sign of utter desperation. And it is on such a massive scale that if it does not work well, we will have a great deal of difficulty containing its effects.

A conventional view of how this plays out comes from Martin Wolf of the Financial Times: the Fed's extreme measures will of course prevail, but at the risk of considerable inflation:

Central banks may soon resort to their most powerful weapons against deflation: the printing press and the “helicopter drop” of money. It is a time for which Ben Bernanke, chairman of the Federal Reserve, has long prepared. Will this weaponry work? Unquestionably, yes: used ruthlessly, it will eliminate deflation. But returning to normality thereafter will prove far more elusive....

Once inflation returns, the central bank will need to sell assets into the market, to mop up the excess money it has created in fighting deflation. Similarly, the government must reduce its deficit to a size it can finance in the market. Otherwise, deflationary expectations may swiftly turn into expectations of above-target inflation. This may also happen if the debt sold in efforts to sterilise the monetary overhang is deemed beyond the government’s ability to service.

Countries without a credible currency may reach this point early. As soon as a central bank hints at “quantitative easing”, flight from the currency may ensue.

more......

http://www.nakedcapitalism.com/2008/12/trepidation-about-quantitative-easing.html

[tama]

1. A quote

"As soon as a central bank hints at “quantitative easing”, flight from the currency may ensue."

Correction: not "may" but "will". Flight from dollar has just began.

[Odin2005]

2. We are in DEFLATION right now, so some inflation won't hurt, and may even be a good thing. n/t

They did devalue the Dollar during the Depression, after all.

[girl gone mad]

3. I think inflation would hurt..

particularly in the face of declining wages and skyrocketing unemployment.

[Odin2005]

4. Mild inflation is far, far better then deflation.

The threat of hyperinflation in overblown, and has mostly been the result of scaremongering by Libertarian nuts like the people that run that Financial Sense site. The Libertarians will be spewing paranoid BS about hyperinflation forever unless we are dumb enough to given them their wish for a return to the Gold Standard.

[girl gone mad]

8. Many smart economists and analysts..

are concerned about the threat of hyperinflation. Paulson and Bernanke have been singularly focused on deflation for more than a year now. They've admitted that they will only attack one tail of recessionary dragon. Hyperinflation is not even on their radar and they would be unprepared to halt it.

http://www.nakedcapitalism.com/2007/05/fed-out-of-control.html?widgetType=BlogArchive&widgetId=BlogArchive1&action=toggle&dir=close&toggle=WEEKLY-1228021200000&toggleopen=WEEKLY-1228021200000

http://www.nakedcapitalism.com/2008/12/deflation-has-become-inevitable.html?showComment=1229178720000

I think we're stuck with deflation for the near term, but maybe Roubini is right that hyperinflation could come into play in a couple of years.

Can you imagine how much worse things would be right now if oil prices were still going up?

[RedEarth]

5. I AGREE we do have deflation now

I also agree with Yves Smith at naked-capitalism when he says "I (literally) have a very bad feeling in my stomach. This move is a sign of utter desperation. And it is on such a massive scale that if it does not work well, we will have a great deal of difficulty containing its effects."

The point he's making through-out the entire 3 page post is the problems are so enormous and so complex that even with the Fed pulling out all the stops it still might not be able prevent a major meltdown. And as he says in the part quoted above the Fed's action "is on such a massive scale that if it does not work well, we will have a great deal of difficulty containing its effects."

Bottom line, these are very treacherous times.

[Odin2005]

6. IMO Bernanke is doing all he can do right now,the ball is now in Congress's and Obama's court

[HamdenRice]

7. Terrifying: I'm not worried about inflation, per se, but high interest rates on fed debt

Right now, there is so much money desperate for a safe place to go that the effective cost of federal borrowing is zero.

That's great because it means that Obama can finance a massive stimulus plan with basically "free" money.

But the Fed's signaling the helicopter money strategy and inflation means that investors in t-bills will demand a premium over future inflation. If the spigot of cheap money to the Treasury dries up, we're seriously screwed.

I think that Bernanke did the right thing in making a market in corporate debt, but this inflation thing is dangerous -- not because of the risk of hyper-inflation, but the drying up of cheap money to finance the federal debt, including what is expected to be a massive increase in federal debt.

Better to wait till January and inject money into the system through fiscal stimulus than inflation.