QE3 – Do We Need More Quantitative Easing?

| March 10, 2011 | 0 Comments

There’s been plenty of talk recently about the end of QE2… and the possibility of QE3.  As you can imagine, there’s no agreement on what should be done… just a lot of arguing.

Even the Federal Reserve Board members don’t agree.  They’re arguing about the effectiveness of quantitative easing.  They disagree on whether QE2 should end in June.  And of course, they’re debating the need for a QE3.

So did quantitative easing actually work?  And, do we need QE3?

Here’s what I think…

It’s hard to say how effective quantitative easing has been.  But I’ll get back to that in a minute.

First off, let me say this… we don’t need a QE3.

The premise of the QE programs is to get money flowing through the economy.  It’s supposed to ultimately benefit the average American by providing liquidity to the financial system.

In other words, the banks are expected to inject money into the economy by making lots of loans.  These loans are supposed to be extended to small businesses and middle class people buying homes.

So, can you show me the money?  Because I certainly don’t see it flowing on Main Street.

And if QE1 and QE2 didn’t get money into the hands of the American public, there’s definitely no need for QE3.

Let me tell you what’s really going on…

During the QE process, the Fed buys Treasury securities off the books of the major banks.  The proceeds from the bond sales go into the banks’ reserves.  In theory, the higher a bank’s reserves are, the more loans the bank is supposed to make.

You see, by regulation the amount of money loaned out by a bank is limited by the amount of reserves they hold.  Higher reserves mean more money can be loaned out.

What’s more, bank reserves don’t earn a lot of interest.  They collect interest at the Fed Funds Rate, which is a miniscule 0.25% right now.  When the banks’ money was locked up in Treasury securities, it was earning a much higher rate of return.

The idea is banks would lend out more money to make up for the loss of interest from going from Treasuries to reserves.

But that’s not what happened.

It turns out banks just did the same old thing… loan money to the rich, allow hedge funds to use massive leverage, and basically do nothing to help those who need it most.  Mostly, banks just held on to their reserves – claiming it was too risky to make a bunch of new loans.

And the numbers back this up.

There’s an economic statistic called M2.  Basically, it’s what economists use to track the money supply.  M2 includes actual cash (bills and coins), checking accounts, savings accounts, most CDs, and most money market funds.  It’s the money we have access to at short notice.

Large increases in M2 tend to be a signal of inflation.  More money in circulation usually means more spending… and eventually higher prices.

Here’s the thing…

Since the Fed started quantitative easing, M2 has barely increased.

In fact, over the last year, M2 in the US has gone up just over 4% – well under historical norms.  Meanwhile, China’s M2 has soared well over 20% during the same time frame.  Inflation is a real concern in China… and that’s why they’re aggressively raising rates.

Okay, so it’s pretty clear the banks aren’t lending out money to mainstream America.  So, I see no point for a QE3 –and judging by recent comments, most of the voting Fed members agree with me.

So it begs the question… were QE1 and QE2 a big waste of time?

Actually, I believe they served their purpose.

You see, it has nothing to do with banks making more loans (they didn’t).  But it had everything to do with perception.

The American public – particularly the ones who invest – felt confident the Fed wasn’t going to let the banking system collapse.  And most people felt sure the economy was going to be safe from deflation.

So, they put their money back in to the stock market.

It wasn’t just the institutions either.  Small and retail investors came back to the market in a big way in 2011… to the tune of $7 billion.  And consumer confidence finally started approaching reasonable levels after hanging out in the gutter for the last couple years.

Investors believed the Fed was going to protect the economy.  So they acted on those beliefs.  In a sense, the Fed accomplished its goals because of this perception of safety.

That being said… inflation is finally starting to rear its ugly head – most notably in oil prices.  It’s time to end the perception of free flowing money the Fed has created.  Let QE2 end.  And just say no to QE3.  One thing’s for sure – the banks didn’t show us the money.  So it’s time for them to get cut off.

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Category: Bonds

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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