UNLIMITED QE3: Money For Nothing

By N Mark Castro

In its hope to stimulate the economy and to spur growth, the US Federal Reserve will unleash it’s third Quantitative Easing or QE3, but while whole word awaited for the QE3 announcement, it got instead an Unlimited QE3, and the question raised in this part of the world is its likely impact on equities, growth and inflation in Asia.

What is Quantitative Easing?

Short answer: It’s an unconventional monetary tool used by central banks to stimulate the economy.

Answer that might make sense: Normally, when there’s a recession or the economy is limping along, the Federal Reserve will reduce short-term interest rates in order to spur more lending and spending. But right now, the Fed has cut interest rates as far as they can go and the economy is still struggling. This is known as the “zero bound.” The Fed can’t go any lower.

So, instead, the central bank can try quantitative easing. Since the Federal Reserve can just create dollars out of thin air, it can buy up assets like long-term Treasuries or mortgage-backed securities from commercial banks and other institutions. This pumps money into the U.S. economy and reduces long-term interest rates further. When long-term interest rates go down, investors have more incentive to spend their money now.

In theory.

Quantitative Easing should work in two ways. First, it injects more cash into banks, allowing them to lend more. And second, it lowers interest rates — if the Fed buys up a bunch of mortgage-backed securities, for example, that should make it cheaper to borrow money to buy a house. In practice, interest rates do drop. But it’s hard to figure out whether this translates into a boost in the actual economy. After all, low mortgage rates can only do so much if banks are scarred by the housing bubble and remain tightfisted about lending.

And the US Federal Reserve has down this twice. The debate is still open whether or not, if indeed, it had boosted the economy, considering that we’re on the 3rd round of QE. Of course, the other end of the spectrum is that it has at least arrested the US economy for going through another depression.

HOW DOES IT WORK?

To buy bonds, the Fed essentially creates money from nothing, paying for its purchases by crediting the accounts of banks from which it buys the bonds. That’s a clue as to how it works — central banks usually strengthen the economy through a single, vastly powerful tool — lowering interest rates. When the Federal Reserve makes it cheaper for banks to borrow money, that stimulus generally flows through the entire economy, as the banks make loans that in turn stimulate economic activity.

But when times are so dire that banks are reluctant to lend or borrowers to borrow whatever the cost, interest rate cuts lose their punch. That happened in Japan after the bursting of its real-estate bubble in 1991, and happened again in the wake of the credit crisis that upended Wall Street in the fall of 2008. In those circumstances, central banks turn to what economists call “quantitative easing’’ — unorthodox methods of pumping money into an economy and working to lower the long-term interest rates that central bankers do not usually control.

And this new QE3 program, compared to previous rounds of easing, has a new twist.

What the Fed announced is an open-ended program to buy bonds until the economy improves. In other words, they will keep injecting money into the economy until growth picks up and unemployment starts dropping significantly. Essentially, Ben Bernanke is trying to shift expectations about the future course of the economy.

Don’t you just love financial astrology?

And now that QE3 is here, will this new measure actually boost the economy and spur job growth?

Catherine Mann, a Brandeis professor and former Federal Reserve economist doesn’t think so.

“The Fed continues to want the economy to grow faster and specifically, to grow more jobs, but the ability of QE to do that is extraordinarily limited,” she told CNN. “We know that QE reduced interest rates, but we also know that has not led to more construction, more mortgages, more business investment, or more lending. Since it hasn’t done any of that, it probably hasn’t created jobs either.”

US PRESIDENTIAL ELECTIONS IMPACT.

The claws are out and the critics are weighing in. The Republicans will continue to use it that this action has been made to lift Obama’s economic policies. The Democrats are insisting on the Fed’s independence.

If Obama wins the presidential election and the economy continues to dip for most of his second term, it has the potential to do lasting damage to his party in the 2014 midterm and the 2016 presidential with a comparatively weak Democratic bench because the real political impact of QE3 might not be felt between now and November but rather in January and beyond.

WHAT DOES QE3 MEAN FOR ASIA?

They see such a move flooding markets with dollars, weakening the U.S. currency, and pushing up the prices of dollar-denominated commodities, as stronger economic activity boosts demand.

Unfortunately, commodities offer few pure plays for those betting on a new shower of money. A big exception: gold, to which investors flock when they believe paper money is being debased by excessive creation. In general, QE tends to be negative for the dollar, and positive for gold and other hard assets seen as an alternative and hedge against devaluation and inflation.  That’s been the case for gold since 2008.

What are Indonesian’s favorite commodity again?

About Asmartrock

N. Mark Castro is the chief political communications strategist for PT AsiaLeads, a political and communications policy-making body based in Jakarta, Indonesia. He is also the Executive Director at the Southeast Asia Consulting Group, an investment advisory company assisting clients roll out their presence for the ASEAN Economic Integration in partnership with government. The views posted here are his own and do not in any way reflect the views of the companies he represents.

Posted on September 14, 2012, in General, Politics, Previous and tagged , , , , , , , , . Bookmark the permalink. Leave a comment.

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