What QE2 Means for You

Published November 15, 2010

Many people have been singing the praises of the Federal Reserve’s new round of “Quantitative Easing” to the tune of nearly $1 trillion, but a new chorus is trying to drown them out.

In newspaper advertisements and an open letter to Federal Reserve Chairman Ben Bernanke, some economists who were prominent in recent Republican administrations warn the Fed’s “QE2” plan risks “currency debasement and inflation.” They also “disagree with the view that inflation needs to be pushed higher.”

Austrian school economists and other free market-oriented economists and financial investors have been saying much the same all along.

$900 Billion More
The Fed plans to buy $900 billion of government bonds through June 2011. This includes using $300 billion of proceeds from maturing mortgages in the Fed’s asset portfolio for bond purchases in the next eight months.

This program follows some $1.7 trillion of new money the Fed pumped into the system in the wake of the financial crisis starting in 2008.

Quantitative easing simply means creating more money. Normally the Federal Reserve buys government bonds passively to maintain its interest rate target. With quantitative easing, the Fed aggressively buys government bonds and other securities in large quantities.

Money for Banks
How does the Federal Reserve create money? First, it buys government bonds and other financial securities from big New York City banks. It pays for them with newly created electronic money, using computers to change the records of the banks’ accounts at the Fed.

If the banks want paper dollars, they receive Federal Reserve Notes. The Department of the Mint at the U.S. Treasury prints and sends crisp new dollars to the Federal Reserve, which forwards them to the banks.

People with inside information, or well-informed guesses, can make tons of money off this process. Some bond traders and big banks are making a killing off of QE2.

Money Misallocation
The Fed says quantitative easing will reduce interest rates and thus increase investment spending, which will boost employment and help the economy recover. The truth is different. Printing money distorts markets and slows the recovery as capital is again misallocated.

That was what caused the housing bubble of recent years and the tech bubble before it. A Chairman Bernanke told us from 2005 to 2007 there was no housing bubble and that everything was fine.

In addition to the threat of new bubbles, there is the more immediate and visible threat of price inflation. The value of the dollar has fallen by 13 percent over the last five months. The September Producer Price Index showed meat prices were 5.2 percent higher and gas prices rose 6.1 percent.

Meanwhile, interest rates are at historically low levels. For retirees and savers this has virtually eliminated safe interest income and forced people into riskier assets.

Stable Gold, Shaky Dollar
Given all the Fed’s money printing, we shouldn’t be surprised that the price of gold is up 24 percent this year. The reason the price fluctuates is that the value of the dollar is fluctuating, in this case plummeting, not that the value of gold has become unstable.

Quantitative easing—printing money—cannot help the economy recover, and in many ways it makes the economy and the dollar more unstable. It certainly is a bad deal for consumers, retirees, and savers. The only beneficiaries are large multinational exporters, dealers in government bonds and securities, and money managers with inside information.

Economic recovery will occur not because of quantitative easing, but in spite of it.

Mark Thornton ([email protected]) is an economist and senior fellow at the Ludwig von Mises Institute in Auburn, Alabama.