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The Real Cost of Quantitative Easing

Posted by Larry Doyle on November 5, 2010 9:49 AM |

Life is ultimately a matter of perspective.

Two people can look at a situation and see decidedly different things. Having been traveling for the better part of this week, I got home late last night to check on how markets closed yesterday. When I saw that equity markets rallied 2 per cent, commodities rose a like amount, and bonds also increased in value, I was not surprised but I was not thinking that I had reason to be cheerful either. I merely raised my eyebrows and went to bed knowing full well that to many people in our nation, these market movements would have little to no impact on their daily lives and immediate futures.

Am I being excessively pessimistic in my assessment?

I will let others weigh in on that, but from my standpoint I believe our markets have lost so many participants over the last twelve to twenty-four months as to render them less meaningful in our daily lives. Our central bankers clearly feel differently. I guess that is where this ‘perspective thing’ comes into play. That said, as I have always maintained, ‘the market is the market’ so I take neither pleasure nor pain in thinking of the major tidal type movements within our markets during this period.

While markets gyrate and escalate, let’s keep our heads and once again navigate the global economic landscape. To that end, we need to go overseas in an attempt to provide a wider angle view of Mr. Bernanke’s quantitative easing experiment. The Financial Times provides two exceptionally interesting perspectives on this topic. The other day Harvard economist Martin Feldstein weighed in that while quantitative easing may move markets, it will not truly move the economy. The FT wrote, QE2 IS Risky and Should Be Limited,   

The Federal Reserve’s proposed policy of quantitative easing is a dangerous gamble with only a small potential upside benefit and substantial risks of creating asset bubbles that could destabilise the global economy. Although the US economy is weak and the outlook uncertain, QE is not the right remedy.

Like all bubbles, these exaggerated increases can rapidly reverse when interest rates return to normal levels. The greatest danger will then be to leveraged investors, including individuals who bought these assets with borrowed money and banks that hold long-term securities. These risks should be clear after the recent crisis driven by the bursting of asset price bubbles. Although the specific asset prices that are now rising are different from last time, the possibility of damaging declines when bubbles burst is worryingly similar.

The problem now extends to emerging markets, a group not directly affected in the last crisis.

Speaking of emerging markets, what do representatives of those nations have to say about our central bank’s experiment and its impact on their markets? Let’s go overseas once again as the FT writes, Backlash Against Fed’s $600 Billion Easing,

The US Federal Reserve’s decision to pump an extra $600bn into the economy has galvanized emerging market central banks into preparing defensive measures and sparked criticism from leading global economies.

The Fed’s initiative, in response to rising concern about the weakness of the US economy, has fuelled fears of a sharp drop in the dollar and a fresh flood of capital inflows into emerging markets.

China, Brazil and Germany on Thursday criticised the Fed’s action a day earlier, and a string of east Asian central banks said they were preparing measures to defend their economies against large capital inflows.

Guido Mantega, the Brazilian finance minister who was the first to warn of a “currency war”, said: “Everybody wants the US economy to recover, but it does no good at all to just throw dollars from a helicopter.”

Mr Mantega added: “You have to combine that with fiscal policy. You have to stimulate consumption.” Germany also expressed concern.

An adviser to the Chinese central bank called unbridled printing of dollars the biggest risk to the global economy and said China should use currency policy and capital controls to cushion itself from external shocks.

Interesting perspectives? Exceptionally so. In an attempt to incorporate these views into those solely focused on our markets, I am compelled to address what I view as the real cost of the Fed’s quantitative easing program. What is the Sense on Cents perspective of that cost? It is actually very simple. It’s called credibility.

Tim Geithner, Ben Bernanke, Barack Obama, and our future central bankers and political leaders have significantly less credibility and leverage on the global stage. When they try to address an undervalued Chinese yuan and any other perceived economic imbalances, they should be prepared for a large middle finger salute in return.  

This reality is merely another step in the ongoing ‘Prisoner’s Dilemma’ that is our global economic landscape.

Credibility is a close cousin of integrity. Losing credibility and integrity are exceptionally steep prices to pay for  future generations in our nation.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. As President of Greenwich Investment Management, an SEC regulated privately held registered investment adviser, I am merely a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

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