What Amount of QE2 Separates a Healthy Economy From Hyperinflation?
Somewhere between $10 and $10 trillion of quantitative easing, the Fed becomes a board of ill repute.
This joke is attributed to George Bernard Shaw:
Shaw was at a party once and he told this woman that everyone would agree to do anything for money, if the price was high enough. "Surely not," she said. "Oh yes," he said. "Well, I wouldn't," she said. "Oh yes you would," he said. "For instance," he said, "would you sleep with me for... for a million pounds?" "Well," she said, "maybe for a million I would, yes." "Would you do it for 10 shillings?" said Shaw. "Certainly not!" said the woman, "What do you take me for? A prostitute?" "We've established that already," said Shaw. "We're just trying to fix your price now!"
Suppose I hacked into my checking account and added three zeros to the balance. Then I go to Goldman Sachs (GS), open an account, and buy a few million dollars worth of Treasuries. I pay for the Treasuries by transferring money from my checking account. Now, you can call that fraud, but I'm just calling it a personal QE2. I'm just a loyal American, helping out the country, just like the Fed.
Last Friday the Fed started on its latest round of quantitative easing (QE). It plans to buy $600 billion of Treasuries by the end of next June, and it claims that it technically is not printing money.
If QE is not printing money and it's good for the economy why doesn't the Fed just buy all the Treasuries? Who needs the Chinese when the Fed just adds zeros to its checking account and buys? The Chinese threaten to dump all $868 billion of Treasuries? Bah, that's nothing for this Fed. They don't even need a full zero when they already have a trillion-dollar balance sheet.
Everybody knows the answer to that. A government can't print/create an unlimited amount of money because it will lead to hyperinflation. History is littered with examples.
Somewhere between $10 and $10 trillion of QE, the Fed becomes a board of ill repute. There's some amount of QE that tips the economy into hyperinflation. What's that magic number? The Fed believes that it's still lady-like at $600 billion, but there's a growing chorus of countries and people that are questioning the way the Fed is dressing.
The Wall Street Journal and New York Times will have open letters this week to Ben Bernanke from a number of leading economists and investors worried that QE2 is dangerously close to the magic number. (Granted, most are Republicans, but on the other hand, Bush appointed Bernanke to his first term as Fed head.) Come January, Ron Paul will take over as Chairman of the House Subcommittee on Domestic Monetary Policy. Paul intends to use this committee to deal with monetary policy.
The debate as to the size of the magic number will continue. Alan Blinder, former vice chairman of the Fed, has an op/ed piece in the Wall Street Journal today defending Ben Bernanke, but not the $600 billion so much. Quoting Blinder: “To create the fearsome inflation rates envisioned by the more hysterical critics, the Fed would have to be incredibly incompetent, which it is not.” If you want to see fearsome inflation, take a look at some of the food and energy commodity price charts the last few months.
Let me go back and quote Bernanke: "At this juncture ... the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained," Bernanke said in prepared testimony to Congress' Joint Economic Committee. That was March 28, 2007. Bear Sterns, Merrill, Lehman, Countrywide, and Wachovia were still a long ways away when he made that statement.
Considering the tenuous state of the world economy, I don't think anyone can look out a year and predict anything with confidence.
If there's one thing that Bernanke has to try to maintain, it's the independence of the Fed from direct Congressional meddling. Considering the uproar over QE2, I think Bernanke will not fold on QE2, but he might taper it down over the last few months or stretch it out a little. My guess it that QE3 is off the table. QE3 would be the end of Fed independence.
The market saw QE2 coming in August, and asset prices ran up in anticipation. When will the market see the end of QE and start to discount that? My guess is no later than February/March. As I wrote a month or so ago, asset prices are trying to hold the Mount Saint Helens bulge created by QE2. The Saint Helens event sequence was earthquake-landslide-explosion. A premature ending to QE2 would be an earthquake. The currently projected ending of QE2 will result in a long, slow hissing sound as the bubble deflates, creating a strong headwind for asset prices.
Either way, the outlook for stocks, bonds, and commodities looks challenging for 2011, with potentially more political uncertainty than usual post midterm elections. The third year of a presidential term has historically been strong for equities. The debate over the magic number may well change that.
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