Launch of Quantitative Easing Risks Economic Sustainability

Monday, October 8, 2012, Vol. 127, No. 196

On Sept. 13 Federal Reserve Chairman Ben Bernanke committed to open-ended, limitless “quantitative easing,” or printing money out of thin air.

This announcement comes after two rounds of similar money printing: QE1 in 2009 and QE2 in 2010, both of which were intended to shock the economy into recovery.

As we begin the fourth quarter of 2012, we are either continuing to muddle through the weakest recovery since the Great Depression or, worse, flirting with another recession.

So the Fed is going to print $40 billion a month to buy mortgage-backed securities (MBS), meaning it will expand its debt each month without a pre-defined limit. Additionally, if necessary, the Fed will “purchase additional assets” and “employ other policy tools.” And it will maintain its Zero Interest Rate Policy (ZIRP), which sets the Fed Funds rate at 0.0 percent to 0.25 percent until at least mid 2015.

In other words, the Fed will print money for eternity and keep interest rates at 0 percent for at least three more years. The goal is the so-called “wealth effect,” the opinion that a rising stock market spurs consumers to borrow and spend money.

QE lifts stock prices by pouring newly printed money into the financial system, which in turn pours it into the stock market. Low interest rates push money into stocks as savers and retirees on fixed incomes are scalped and must turn to riskier assets to compensate.

To put this unprecedented action into context, an average person earning $50,000 per year would have to work for 800,000 years to earn the same amount of money the Fed is printing each month via QE3. Put another way, one year of QE3 will create as much money as nearly 10 million households will have earned. No work is required, no production is necessary. All it takes is pushing a computer key a couple of times.

This has been tried repeatedly throughout history and always ends in unmitigated pain and suffering, especially for the poor and middle class. The denouement comes with the destruction of the currency and social disorder.

As John Maynard Keynes said: “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

Money printing cannot create strong long-term economic growth and prosperity; on the contrary, such policies destroy currencies and catapult economies into depressions. Eventually, the market must clear out unsustainable debt, unsustainable banks, unsustainable business models – and, hopefully, unsustainable economic theories.