QE2
Oct 28, 2010
Posted by Jody Eisenman | Filed under Uncategorized
No, it’s not the new Queen Elizabeth ship. QE2 refers to the Feds’ policy of Quantitative Easing 2, which is expected to be announced at the upcoming Fed meeting next week. The first quantitative easing took place in 2008, when they bailed out the banks (and lots of other companies). During this time, the Fed purchased nearly $2 trillion of assets in an effort to lower interest rates and take questionable (read: bad) assets off the over leveraged books of many financial firms. The hope was that by spending (read: printing) massive amounts of money, people would borrow and spend, thus stimulating the economy. Lowering interest rates would encourage people and businesses to borrow as well. At least, that’s the theory.
At this point, the Fed is facing a quandary. On the one hand, interest rates are quite low. Fed funds are trading at less than ¼ of 1 percent, and two year treasuries currently yield 0.39. On the other hand, the economy is still really slow, and unemployment is still really high. Therefore, the Fed is widely expected to embark on a second program, affectionately known as “QE2”. In this case, the Fed is expected to use $500BB to purchase long term assets, in the hope that this will lower long term rates, and put even more money into the economy. Will this work? Who knows? Economists like Paul Krugman feel that the Fed has never done enough; we need much more spending. On the other hand, you have a lot of economists that feel that this policy is inherently dangerous. Why? Because where is this money coming from? The government is simply printing more by borrowing more. The can continue to do this as long as people are willing to lend, mostly by buying treasury bills and notes. Demand is still heavy as evidenced by such low interest rates. If people (mainly institutions and foreign governments like China and Japan) would scale back, then rates would rise in order to increase demand. So far, this has not happened.
However, the question is, how do you get the genie back in the bottle? In other words, if this policy works, (and it is still controversial), and the economy recovers, then rates will begin to rise. Since the government is a huge borrower, higher interest rates will increase the debt service (the amount of interest they must pay on the debt). In theory, the government should then be running a surplus, which should lead to cutting the debt back, and then we live happily ever after. In theory. The reality is, our federal deficit has gone from under $1 trillion in 1980 to around $13.5 trillion today. Based on current spending, it is expected to reach almost $18.5 trillion by 2014. The last time the federal deficit dropped (meaning that the government spent less than it took in) was in 1951! (see treasurydirect.gov) As any businessman can tell you, when you borrow money, sooner or later, you’re going to have to repay it.
