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Chairman Ben Bernanke made two announcements Thursday about monetary policy: (1) the Federal Reserve will begin its third round of quantitative easing, and (2) it will maintain extremely low interest rates of 0 to 1/4 percent until at least mid-2015. These banking actions may sound like gobbledygook, but their effects on our country’s currency are drastically serious. Let’s translate a few things into layman’s terms.
“QE3” — what’s this mean?
The acronym refers to an unconventional monetary policy called “quantitative easing,” and the subsequent number refers to the specific round of easing. Yes, this means the Fed has already completed two rounds without success.
The stated goal is to stimulate economic growth. At this point the Fed has forced interest rates as low as humanly possible — any lower and lenders would be paying debtors — so the only option left is to create money out of thin air and inject it into the nation’s money supply by purchasing various banks’ financial assets.
What will QE3 entail?
The Fed will buy $85 billion in assets every month until the end of the year. Its purchases will consist of $40 billion in mortgage-backed securities (essentially mortgage debt) belonging to one of our economy’s most depressed industries.
Unlike QE1 and QE2, QE3 is “open-ended.” This gives the Fed unlimited power to extend the year-end deadline. Not only can it continue buying potentially worthless assets “if the outlook for the labor market does not improve substantially,” it admits the practice will probably be used even “after the economic recovery strengthens.”
Ultimately the choice to dilute the USD’s purchasing power is left up to Bernanke’s discretion.
Can we trust Bernanke’s discretion?
Even if QE were a sensible plan, you may ask, how accurate is the Chairman in analyzing economic trends? History’s answer: he’s terribly inaccurate. Let’s hope he doesn’t get into archery. For example, in January 2008, Bernanke explained to reporters, “The Federal Reserve is not currently forecasting a recession.” You’ll see in the graph below — obtained from the Bureau of Labor Statistics — that his embarrassing forecast was followed immediately by skyrocketing unemployment.
On the other hand, Congressman Ron Paul and investor Peter Schiff were predicting the housing crisis-fueled recession all the way back in the early 2000s. So I’m a little wary of Bernanke’s ability to properly understand the business cycle, let alone of giving him the tools that cause the cycles.
What effects will we see?
The balance sheet below — obtained from the Federal Reserve Bank of Cleveland — is a summary view of the central bank’s holdings. You can click the image to view the full-sized chart, or you can check out the Wall Street Journal’s interactive graphic featuring the same numbers.
The amount of mortgage-backed securities is so worrisome because these assets are unstable and don’t disappear after the Fed’s purchase. The securities still exist and have to be released back into the economy at some point in the future. By temporarily flushing them out of the public’s view, the Fed is misleading certain investors and leaving other ones bearish. The release of these securities will be met with the realization that important resources are severely misallocated.
The immediate effects are more straight-forward.
Expect a strong boost to the stock market. The Fed begins purchasing assets today, and that means Wall Street investors who own mortgage-backed securities will have liquid portfolios to spend on other stocks. Typically zero percent interest rates signal you’ll want to invest in industries like banking and housing for a short time while the bubble grows, but, since interest rates are already zero bound, the situation is stickier.
Currency dilution also signals that gold and silver prices will increase. They’ll be used as a hedge against the impending price inflation. Any metal with intrinsic value — the currency advocated by Austrian School founder Carl Menger — will likely follow this pattern.
The details about how QE affects the rich and poor will have to wait for a future blog post. I’ll also explain the relationship between currency strength and the central bank, as well as what that relationship means for our country’s economy. In the end, policymakers will have to choose between two options: (1) monetize the debt through inflation as it’s doing now, or (2) get America back on the path to fiscal conservatism and sound, constitutional money.
What do we do now?
The "Audit the Fed" bill easily passed the House with a 327-98 vote in July. Only one Republican — Bob Turner of New York — voted "nay."
Senate Majority Leader Harry Reid is currently blocking the bill from a vote in the upper chamber. Matt Kibbe, President and CEO of FreedomWorks, has written a letter to the Senate urging "yea" votes on Senator Rand Paul's supplement, S. 202.
Join us in our fight for monetary accountability by contacting your senators and telling them to support an audit of the central bank. You can also share Congressman Ron Paul’s FAQ sheet with your friends and family for more information on why this action is important.