By Christina J. Kostopoulou
We only have a month before QE2 end is scheduled and everybody is focusing on what’s going to happen next. As the senior economist of the Euro Pacific Capital wrote recently, “The Fed will find it extremely difficult to absorb the liquidity it has relentlessly dumped into the economy since the beginning of the financial crisis.”
Ben Bernake has said that he can stop inflation by simply selling all of US assets. The question is what happens if he starts to dump the 1.8 trillion worth of mortgages back securities? What happens to the value of that dept? The balance sheet will run down so fast that he wouldn’t have any assets left to sell. And the money will be left in perpetuity in the system. He cannot aggressively drain his balance sheet. Another question of course is will there be a buyer?
If the price of the mortgage backed securities is very low, you raying mortgage back securities to drain the money already put in. The assets are used and purchased in the first place. Bernake made it clear that they going to maintain the balance sheet and it seems that he might do so until the economic data becomes so negative that he has to construct the QE3. The data so far though seems already pretty weak: housing, regional manufacturing service, unemployment rates.. It’s certainly horrible already, before QE2 even ends on June 30th.
Fed could be doing additional QE, which is easier but it’s a very difficult period now: with oil over $100 a barrel, copper over $4 a pound and gold at nominal heights, all we doing is getting more inflation. It seems okay to monetize dept for a little while, as long as people can get tricked into not raising prices, producing more. After a while though, the dollar is getting crashed, resulting in diminishing returns from further inflation. So FED is in a really difficult spot. If they stop printing money and drain their balance sheets slowly, we going to have another 2008 summer: deflationary depression. If Bernake on the other hand launches more interations of quantitative easing, we are going to have an inflationary depression.
In any case, there’s no way out. If we look at the total dept which is federal, state, local, corporate dept, plus household dept as a percentage of GDP, it has never before been so high. So what happens when we take the path of austerity and deleverage? This dept on the household, the corporate and on the government still has to be paid, creating a deleveraging depression.
Bernake is a political animal but he definitely doesn’t want to do anything until after the 20/12 elections. What’s going to happen until then is that the dollar will simply continue to erode, destroying the middle class.
