The Fed is holding out hope that the third time will be a charm as it unleashed a much anticipated third round of quantitative easing last week, this time pledging to buy $40 billion worth of mortgages per month until the labor market improves. The fact that this announcement came the same week that the IMF apparently suggested that Greece may need a third round of bailout funds is quite ironic. The powers that be have shown themselves to be incapable of solving problems, but are willing to do more of the same just to be doing something. We think the Fed hit the panic button because it sees the important ECRI indicator flashing recession in spite of QE1 and QE2 and operation twist.
Retail sales and industrial production in the U.S. just printed at horrible levels and just about every global manufacturing survey suggests contraction. The Fed appears to be having a hissy fit over the criticism it is receiving for holding deposit rates near zero for years and raising prices at the gas pump and grocery store by encouraging commodity speculation, while the banks get access to free money that they are not lending. We doubt this third round will make much difference to the real economy because we already have an enormous level of free reserves in the system as cash is hoarded and money velocity sits at multi-decade lows. More free reserves from QE3 won’t help!
The economic theory of “pushing on a string” means nothing to Chairman Bernanke. We suppose we can forgive it for its dogged reliance on failed policies because the Fed is dominated by academic theorists, not nuts and bolts practitioners. We have structural unemployment issues remaining from the last Fed bubble and a lot of those jobs are just not coming back. It is quite interesting that the Fed’s new employment or bust mandate is occurring even as the labor department continues to contort employment data in ways to make the unemployment rate look better than reality. The DOL simply moves participants out of the labor force in different ways either through increasing the disability tally or classifying more people as no longer looking for work. Needless to say, sadly, the true unemployment rate is much higher as the labor force participation rate sits at early 1980’s levels.
We have five final points. Similar monetary stimulus did not work in Japan in the 1990’s after their bubble years. Secondly, one only has to look at the continued flight of deposits out of the Spanish banking system to see that huge deflationary forces remain at work in the world as the ECB takes over private banking functions in Europe. Thirdly, that most important source of global money supply growth for the last few years known as the Chinese currency system is now collapsing as exports shrink there and capital heads elsewhere. Fourth, while a major “fiscal cliff” may be avoided in the U.S. in 2013, we will still likely experience a fiscal contraction of at least $100 billion next year. Finally, and perhaps the most direct counter to QE3 is the fact that Fannie Mae and Freddie Mac have recently been ordered to shrink their portfolios of mortgages more quickly to the point where their balance sheets must contract by roughly $700 billion over the next few years. Perhaps the central planners conveniently decided the Fed was the perfect entity to take up that slack…but we do not want to ruin a good reflation story conjured up by Chairman Bernanke, his cronies, and Wall Street.