QE3 – Do We Need More Quantitative Easing?
The Dynamic Wealth Report
March 10, 2011
by Jay Chernoff, Editor
There’s been plenty of talk recently about the end of QE2… and the
possibility of QE3. As you can imagine, there’s no agreement on what
should be done… just a lot of arguing.
Even the Federal Reserve Board members don’t agree. They’re arguing
about the effectiveness of quantitative easing. They disagree on whether
QE2 should end in June. And of course, they’re debating the need for a
QE3.
So did quantitative easing actually work? And, do we need QE3?
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Here’s what I think…
It’s hard to say how effective quantitative easing has been. But I’ll
get back to that in a minute.
First off, let me say this… we don’t need a QE3.
The premise of the QE programs is to get money flowing through the
economy. It’s supposed to ultimately benefit the average American by
providing liquidity to the financial system.
In other words, the banks are expected to inject money into the economy
by making lots of loans. These loans are supposed to be extended to
small businesses and middle class people buying homes.
So, can you show me the money? Because I certainly don’t see it flowing
on Main Street.
And if QE1 and QE2 didn’t get money into the hands of the American public,
there’s definitely no need for QE3.
Let me tell you what’s really going on…
During the QE process, the Fed buys Treasury securities off the books of
the major banks. The proceeds from the bond sales go into the banks’
reserves. In theory, the higher a bank’s reserves are, the more loans
the bank is supposed to make.
You see, by regulation the amount of money loaned out by a bank is
limited by the amount of reserves they hold. Higher reserves mean more
money can be loaned out.
What’s more, bank reserves don’t earn a lot of interest. They collect
interest at the Fed Funds Rate, which is a miniscule 0.25% right now. When the banks’ money was locked up in Treasury securities, it was
earning a much higher rate of return.
The idea is banks would lend out more money to make up for the loss of
interest from going from Treasuries to reserves.
But that’s not what happened.
It turns out banks just did the same old thing… loan money to the rich,
allow hedge funds to use massive leverage, and basically do nothing to
help those who need it most. Mostly, banks just held on to their
reserves – claiming it was too risky to make a bunch of new loans.
And the numbers back this up.
There’s an economic statistic called M2. Basically, it’s what economists
use to track the money supply. M2 includes actual cash (bills and
coins), checking accounts, savings accounts, most CDs, and most money
market funds. It’s the money we have access to at short notice.
Large increases in M2 tend to be a signal of inflation. More money in
circulation usually means more spending… and eventually higher prices.
Here’s the thing…
Since the Fed started quantitative easing, M2 has barely increased.
In fact, over the last year, M2 in the US has gone up just over 4% -
well under historical norms. Meanwhile, China’s M2 has soared well over
20% during the same time frame. Inflation is a real concern in China…
and that’s why they’re aggressively raising rates.
Okay, so it’s pretty clear the banks aren’t lending out money to
mainstream America. So, I see no point for a QE3 –and judging by recent
comments, most of the voting Fed members agree with me.
So it begs the question… were QE1 and QE2 a big waste of time?
Actually, I believe they served their purpose.
You see, it has nothing to do with banks making more loans (they
didn’t). But it had everything to do with perception.
The American public – particularly the ones who invest – felt confident
the Fed wasn’t going to let the banking system collapse. And most people
felt sure the economy was going to be safe from deflation.
So, they put their money back in to the stock market.
It wasn’t just the institutions either. Small and retail investors came
back to the market in a big way in 2011… to the tune of $7 billion. And
consumer confidence finally started approaching reasonable levels after
hanging out in the gutter for the last couple years.
Investors believed the Fed was going to protect the economy. So they
acted on those beliefs. In a sense, the Fed accomplished its goals because of this perception of safety.
That being said… inflation is finally starting to rear its ugly head –
most notably in oil prices. It’s time to end the perception of free
flowing money the Fed has created. Let QE2 end. And just say no to QE3. One thing’s for sure – the banks didn’t show us the money. So it’s time
for them to get cut off.
One of the biggest gainers in the ETF world this week is United States
Gasoline Fund (UGA). It’s up almost 3% today and a whopping 32% over the
last 52 weeks. UGA tracks the performance of unleaded gasoline by using
futures. Gasoline prices are surging higher with the spike in crude oil
price.
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