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Quantitative Easing Will Work... If by 'Work' You Mean 'Postpone the Inevitable'

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QE2... NOT THAT ONE
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Last night I discussed the effectiveness of a second round of quantitative easing with The Nightly Business Report's Suzanne Pratt. The video and transcript are below, interview begins around the 16 minute mark:


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Transcript:

SUZANNE PRATT: Talk about a complicated subject. You`ve probably heard all the recent chatter on quantitative easing and the Federal Reserve. It`s also known as QE or QE2 and there are two ways to play it. Earlier today, I spoke with Kevin Depew of Minyanville and asked him if he could please define it for us.

KEVIN DEPEW, EDITOR-IN-CHIEF, MINYANVILLE: That`s right, Suzanne, it`s a tough concept to grasp but in a nutshell it`s called quantitative easing, quantitative because the central bank, the Federal Reserve is going to take a predetermined quantity of money and they are going to purchase assets directly from banks and thereby increasing cash reserves in the banks. That eases money into the system and into the economy as hoped.

PRATT: And Kevin, financial markets pretty much expect this to happen. Make the pro case for why it would be a good thing for the economy.

DEPEW: Well, the pro case is that it`s going to reduce the cost of debt, the cost of capital for businesses and households. It`s hoped that by reducing the cost of capital for households that that will increase money into the economy. It will increase consumption. I will stabilize housing.

PRATT: And also in terms of what will it do for cash and bonds?

DEPEW: Well, the hope is that it forces money away from low-yielding cash accounts and Treasury bonds which are at historic low yields and force that money into higher yielding assets, riskier assets like stocks.

PRATT: So make the opposite case, the con case, because there certainly are those on that side of the picture who think it will not only be bad for the economy, but it also could damage the credibility of the Fed, et cetera.

DEPEW: Well, I mean that`s absolutely right. Let`s face it. When you get to the point where you need quantitative easing, it means all other policy measures have failed. So the economy by definition has to be in shambles by the time we get to this point. So everybody is going to be a negative about it. Everybody feels bad about it. But the reality is you can`t fight debt by increasing debt. And that`s what the bottom line of the bear case boils down to.

PRATT: Isn't the issue also that interest rates are already so low and people aren`t actually partaking in loans, even though the rates are at historically low levels?

DEPEW: Absolutely. I mean the issue is not the cost of capital. Rates have been 1 percent. The Federal funds rate has been 1 percent or lower for almost a year now. The problem is that there is no availability of funds to households and businesses. Banks are reluctant to lend. They don`t want to lend because they`re afraid they are not going to be paid back which is what happens when the economy is like this.

PRATT: So what is your position on quantitative easing, should it happen or should it not?

DEPEW: Well, if you type in, will QE2 work into Google, you get about 600,000 results, almost uniformly negative. So as a natural contrarian, I think people are a little too pessimistic about what happens with it and it`s only natural because the economy is in terrible shape right now. But it depend on what you mean by work. If by will it work will it postpone the day of reckoning when we have to face up to the fact that we have too much debt supported by too little real productivity and income, then yeah, it will postpone it. Will it work longer term? I just don`t think that that is really going happen.

PRATT: So thank you, Kevin Depew of Minyanville for educating us on this rather arcane topic.

DEPEW: Thank you, Suzanne.

POSITION:  No positions in stocks mentioned.

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