A couple of months after announcing Operation Twist (the fed will exchange short term securities for longer term securities), the Federal Reserve announced QE3 in September. Since then, there have been a lot of mixed reactions. These mixed reactions are the result of clashes between the informed and the uninformed. Ironically, most people who you would normally hear going on an on about the government needing to do more to stimulate the economy had nothing to say in response to QE3. In fact, most of them don’t even know what QE (Quantitative Easing) is. A simple explanation would be — The Federal Reserve buys securities from banks in order to provide more liquidity in the economy. The uninformed might jump for joy and think the government is doing something to stimulate the economy. But hold on, let me explain how this works before you get too excited.
In short, the Federal Reserve (The Fed for short) announced that they’ll be spending $40 Billion per month buying mortgage-backed securities (MBS). I’m not gonna go into what a MBS is, you can look it up online if you’re interested. What this is supposed to do is put more money in the economy, which in turn is a stimulus. Sounds good in theory, right? But let’s do a little digging. MBS’ are a form of toxic debt which The Fed and banks continue to play hot potato with. These MBS’ are worth essentially nothing due to the high rate of defaults that occurred during the 2008 credit crisis. During this crisis, any bank holding MBS’ was pretty much fucked. Because of that, a few big name banks ended up going under.
Sooooooo…since MBS have lost their value and the Fed offers to take them off the banks’ hands, everything is fine, right? Again, let’s do some digging. Let’s say that the Federal Reserve is successful in stimulating the economy, so much so that the economy looks as if its overheating and inflation is about to set in. This is when the Fed will sell the MBS back to the banks, taking money out of the economy, which raises interest rates and is likely to bring on recession. So, what you see is that this bad debt hasn’t gone anywhere.
What does this mean for the economy? For one, it means that the Federal Reserve’s printing presses have been busy. When The Fed runs those printing presses it means that our money begins to lose even more of its purchasing power. In the short term, it may appear that QE3 is actually stimulating the economy. In fact, recent statistics have made it appear that way. Even the markets had a sharp rally after QE3. But now, the markets are declining sharply. Some would say its because of the poor earnings of companies, but there’s something bigger brewing.
For two, it means inflation! When our money loses value, the price of everything goes up. Luckily for the consumer, oil prices have gone down on news of a supply glut, so that should provide some temporary relief before the inflationary effects of QE3 take hold. But wait a minute! If the economy isn’t really growing but we have inflation occurring, wouldn’t that contradict what I said? Not at all! That phenomenon is called stagflation. This is when inflation is high, yet employment remains high and economic growth is slow. In my opinion, we seem to be headed towards stagflation. That’s if we aren’t already there.
But, you might ask, “wouldn’t more money in the economy mean that companies have access to more capital in order to expand, which should in turn lead to more hiring?” Ideally, that would be the case. But with the entire economic outlook being so uncertain, business owners aren’t running to their creditors for loans, so that will put a damper on hiring. If anything, companies will turn to temp services first before deciding to hire full-time employees. Thanks to your government and their hiring tax, business owners would much rather deal with a temp service than hire someone full-time because hiring costs a lot of money.
So if you ask me what does QE3 mean for the economy, I would have to say that stagflation will be the result. I honestly don’t see any other result that could stem from the actions of The Fed and Congress.