In the interest of being devil’s advocate, I will elucidate a nice argument in favor of QE2. It’s not mine, but courtesy of the Northern Trust Bank.
The theory is this. The Fed can create money out of thin air, and so can commercial banks as long as they have the seed money from the Fed. In QE1, the Fed created money, but the commercial banking system didn’t create any money. QE1 didn’t work. In reality, credit contracted by $625 billion in QE1.
From the Northern paper, “Notice that although Federal Reserve outright holdings of securities increased a net $1.5 trillion during the first round of Fed quantitative easing, total Federal Reserve credit increased by only a net $200 billion during this period because other elements of Federal Reserve credit contracted by a net $1.3 trillion.”
Northern Trust also thinks that the time is right for QE2. They say, “in the seven months since the end of QE1, the rate of contraction in other elements of Federal Reserve credit besides outright securities holdings has slowed significantly. In the seven months ended October 2010, these other elements of Federal Reserve credit have contracted by only a net $36 billion. If these other elements of Fed credit continue to contract by only a small amount or stabilize, then the Fed's planned $600 billion net increase in its outright securities holdings will make almost a dollar-for-dollar increase in total Federal Reserve credit.”
Northern also finds signs that commercial banks are beginning to lend. “In each of three months ended September 2010, commercial banking system credit increased. The latest Federal Reserve survey of bank lending practices, which covered the three months ended July 2010, showed a significant increase in the percentage of respondent banks easing their lending standards. The actual recent behavior of commercial banking system credit and the results of the recent Federal Reserve survey of bank lending practices suggest that commercial banking system credit will be a considerably smaller drag on combined Federal Reserve and commercial banking system credit creation or perhaps make a small positive contribution during the second round of Federal Reserve quantitative easing.”
But what about our trading partners and international economies? In the past few days, the US has been severely chastised by the Chinese, Germans, and other countries for its monetary policy. Northern sees some risks, but only to countries that use a dollar peg (China). US inflation may get exported overseas. If a central bank wants to try and manage its currency relative to the US dollar, it can engage in open market operations to buy up US dollars. The alternative is accept the appreciation of their currencies relative to the US dollar. For economies like Germany, this is a Solomon’s choice. Japan cannot be happy either, since they just tried to devalue the Yen a month ago.
All this monetary machination is not done in a vacuum. Macroeconomic effects, globalization, and US fiscal policy will also determine the value of the dollar. Northern estimates that GDP will be 3.0%, down from 3.4%. The reduction is due to state/local government budget cuts, and a drop in residential investment expenditures.
I’d go further. Any drop in GDP can be directly related to US tax and trade policy. The Fed has had accommodative monetary policy for a long time. If the US extends current tax policy indefinitely, it brings certainty to the investment environment. Any trade pacts where free trade is encouraged between the US and another major economy will increase job growth, production and GDP. Currently, the Republicans are in South Korea trying to hammer out a trade pact with them. Congressman Peter Roskam is on Don and Roma’s radio show tomorrow morning to speak about it.
Monetary policy can make it easier. Fiscal policy creates the definite incentives for behavior. Politicians don’t create jobs, but they do put in place the gridiron necessary for job growth. Entrepreneurs fill in the gaps.
Devil’s Advocate to Northern Trust’s points
It may be true the Fed QE1 didn’t work because the commercial banking sector didn’t cooperate. Their customers lost their appetites to take risk. The banks also had tough credit standards. Even if the banks are loosening credit standards, what makes anyone think that the private sector is ready to take more risk? The only changed incentive is money is cheaper.
The political environment has changed, but the roadblocks to growth are still in place. Obamacare, Fin Reg and many other rules and regs are relics from the last Congress. They will be extremely hard to repeal. Outright repeal may not happen until after November of 2012. The private sector assumes current tax policy will be extended in the lame duck session, but that assumption is risky. Democrats look like they are playing hard ball, refusing to seat winners like Mark Kirk and proposing card check and other liberal bon bons. The political environment will still be difficult, until Obama is out of the White House and limited government fiscally conservative Republicans control the Senate.
Will Obama sign on to free trade agreements? A very open question. Pre-eelction they were on the table and didn’t move. Now they are moving. We will know shortly.
I don’t think the situation approves until the employment situation improves. The only way to do that is create incentives to hire people. End corporate taxes, eliminate the capital gains tax. Unemployment will drop like a rock.
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