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Quantitative Easing II: The Ship Is Leaving the Dock


The key question is, how much? If unemployment increases or fails to trend down, QE2 could explode to well beyond $1 trillion.

Editor's Note: This article was originally published at The Daily Capitalist.

You can always tell when something's up when the Fed presidents are making news. For the past several days we've heard Ben Bernanke, James Bullard (St. Louis), and now Charles Evans (Chicago) talk about quantitative easing (QE). The NY Fed's President William Dudley and Brian Sack Executive Vice President in charge of carrying out FOMC decisions, have made major speeches about it. You have to understand that the Fed always has a purpose in its communications with the public, and rarely do its interlocutors stray from the official script.

The gist of each of these communiqués has been that the Fed will soon, perhaps by the November 2 meeting, start massive additional purchases of Treasurys in order to create inflation. They wish to create inflation because they're clearly worried about "deflation."

Note: In order to not confuse my readers, I need to be more precise in how I define inflation and deflation. My definitions are different than the Fed's. The Fed and most economists say inflation is a general rise of prices and deflation is the opposite, a decline in prices. In Austrian theory, inflation is an increase in money supply and deflation is a decrease in money supply. Thus inflation and deflation are monetary phenomenon. One of the results of inflation is rising prices. Other impacts are a distortion of the entrepreneurial process which leads to our typical boom-bust business cycles. I'll refer to the Fed's usage as "price inflation" or "price deflation."

According to a recent report by Goldman Sach's Jan Hatzius, as reported in today's Zero Hedge by fellow reporter Tyler Durden, Goldman believes that the Fed will buy at least $500 million of medium-term Treasurys, probably $1 trillion, and "possibly much more."

The Fed hierarchy believes that price inflation is necessary to enable them to carry out their mandate: maintain stable prices and full employment. They'll attempt to stimulate the economy by massive quantitative easing, a process by which the Fed monetizes the debt of the federal government. This is one of the ways the Fed can expand money supply. Price inflation, they believe, will create economic activity by reducing the debt burden on borrowers, maintain asset values, improve credit, and create additional income from consumers. And, importantly, they believe it will prevent price deflation.

Today I went through 30 pages of reports including the official texts of Messrs. Dudley's and Sack's speeches, whom I believe to be the most important players at the Fed next to Ben Bernanke.

What's infuriating to me is that they still don't have a clue why i) the boom-bust cycle occurred, ii) why the monetary and fiscal remedies have failed, and iii) what will happen when they print massive amounts of money in QE ($1 trillion plus).

President Dudley, according to my review of his lengthy speech, is the ultimate post-Keynesian, neoclassical, econometrician Monetarist tinkerer. He states that the Fed can set goals for the economy with some precision and carry them out. I believe that much of this kind of talk is "communiqué" from the Fed that's meant to make financial actors believe that the Fed is in control of the situation. He says:

"As the central bank, we and we alone can control inflation -- if not precisely in the short run, then over the medium term. By clarifying our intentions, we can reduce the risk of further disinflation."

And, in reference to the Fed's exit strategy, he said:

"[T]he Federal Reserve has the tools to control financial conditions and credit creation even with an expanded balance sheet."

In fact they're far from being in control, and Dudley's speech is both fascinating and frightening at the same time. One could raise the questions: If they were in charge of things, i) why did they let the crisis happen, and ii) why haven't they revived the economy two years after October 2008?

I'm going to take you through Mr. Dudley's speech and point out to you why we're in so much trouble.
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