purpose of quantitative easing

So I was reading ZeroHedge, and apparently China's largest state run english newspaper is accusing the US of actively attempting to debase its currency.

http://www.zerohedge.com/article/empire-strikes-b…

Ignoring the hypocrisy of the Chinese, what do you guys think of the idea that the Fed's main purpose behind the next round of quantitative easing is stimulus through inflation/currency debasement?

To the best of my understanding, quantitative easing/other federal reserve stimulus is usually mainly aimed at encouraging bank lending, by driving down interest rates and giving the banks lots of excess reserves to lend out, which should in turn spur real GDP growth.
But stimulus in this way might not work now because:
a. banks are sitting on nearly a trillion of excess reserves
b. there is little loan demand

But what if the federal reserve is hoping to help the economy not by making credit more readily available, but by using currency debasement/inflation to stimulate the economy in other ways?
possible benefits:
a. weak dollar means exports will make up for the demand decrease from american consumers
b. the general public will be able to pay off their debts quicker because of inflation, spurring faster return to 'normal' GDP growth
c. the US government will be able to pay off its debts more easily because of inflation, assuming bondholders don't catch on and demand higher interest rates

I know it sounds out there, but what do you guys think?

 
squirtlez:
to make me money on shorting treasuries!

What are you talking about, it would do the exact opposite...

Jack: They’re all former investment bankers who were laid off from that economic crisis that Nancy Pelosi caused. They have zero real world skills, but God they work hard. -30 Rock
 

Just for the record, the Fed is actively trying to debase the currency. That's all part of the plan. Weak dollar = greater exports. The Chinese are bitching because they think they have a right to have the weakest currency on the planet, and don't like the competition. If the Yuan were allowed to float, it would probably double in a day against the dollar.

We're heading into a global trade war as more and more governments race to devalue their sovereign currencies to spur international demand for their goods. The Chinese might be bitching the loudest, but they're certainly not the only ones bitching. The Euro Zone countries are screaming bloody murder about the Euro's recent rise against the dollar.

The Fed is about to find out that Keynes was wrong and they don't have a magic wand.

 

I'm pretty sure everyone agrees the point of QE2 is to debase the currency; the main question is whether Bernanke has the balls to actually do something, or if he's completely forgotten everything he wrote when he still had balls, and the US will do the best damn imitation of Japan you can imagine. The reason the EU is pissed is because the yuan is pegged to the dollar, so while dollar debasement will increase US competitiveness, that will come mostly at the cost of Europe and developing nations that lack China's monetary firepower, not of China herself. Also, because the ECB is petrified of inflation because they are still living in 1922 and thus won't do the reasonable thing and launch their own quantitative easing in response, when the early 1930's are the more relevant precedent.

 
drexelalum11:
I'm pretty sure everyone agrees the point of QE2 is to debase the currency

This is far from the truth. The purpose of QE2 is not to devalue the dollar. The purpose of QE2 is to lower mid-to long term interest rates to spur capital investment and hiring and also to increase inflation expectations. Any increase in exports will just be an added benefit.

The real question is are the benefits worth the costs? Will the additional QE complicate the Fed's exit? If the QE does not work will the Fed lose credibility? With rates already so low, how much can a $500B purchase really help?

 

Yes, the stated purpose is to lower interest rates, but with demand for credit so low, and the likely impact upon interest rates so nominal (which, as you and Anthony pointed out, are already extremely low), the real effect will be to debase the US currency and increase competitiveness. Your point about QE exit is a fair one, but your point about credibility is not. Central banks have two forms of credibility; one is important, one is not. When Bernanke hinted QE2 is coming, the markets reacted; this is because markets view a statement by the Fed Chairman as credible, and expect him to keep his word; if he does not, the Fed loses some of its power. This form of credibility matters. The other form is the sort that Joe Congressman cares about; did the Fed's actions have its desired effect, or can Joe Congressman whip up some populist rancor by denouncing Bernanke and calling for increased auditing of the Fed. This is the form of credibility to which Heinz's refers, and this should not factor in to the FOMC's decisions. Unfortunately, it appears that it will.

 

What's your point? Do you understand that shorting treasuries means long rates i.e. trading against QE.

Jack: They’re all former investment bankers who were laid off from that economic crisis that Nancy Pelosi caused. They have zero real world skills, but God they work hard. -30 Rock
 

Can someone explain (in layman's terms) exactly how our low interest rate policy is exported to other countries around the world? Is it only countries that peg to the dollar? How does our low interest rate policy ease credit around the world?

 
wso2010:
Can someone explain (in layman's terms) exactly how our low interest rate policy is exported to other countries around the world? Is it only countries that peg to the dollar? How does our low interest rate policy ease credit around the world?

Lower US interest rates means that other countries around the world have to keep their interest rates low or their currencies will run the risk of appreciating against the USD, this will make their exports more expensive and their USD denominated debt more expensive to pay back.

 
dec-jun-jun:
wso2010:
Can someone explain (in layman's terms) exactly how our low interest rate policy is exported to other countries around the world? Is it only countries that peg to the dollar? How does our low interest rate policy ease credit around the world?

Lower US interest rates means that other countries around the world have to keep their interest rates low or their currencies will run the risk of appreciating against the USD, this will make their exports more expensive and their USD denominated debt more expensive to pay back.

correcting my own comment, stronger domestic currency will actually make the USD denominated debt less expensive.

 

it doenst directly impact their decision to lend. it stimulates banks' borrowing amongst each other because they can borrow at cheaper rate and then using those funds to lend out to businesses. even if they get cheaper loans to finance their business, it doesnt mean they will lend all of what they borrowed, or any at all for that matter, but when market conditions improve they usually do, then businesses get to loans and the economy keeps moving.

 
PocketHandkerchief:
Quick question: Weak USD = Increased demand for US Exports.... but what the hell are we exporting??? IPads??? US doesn't make actual shit.

The US is the number one manufacturer in the world in terms of nominal output. On top of that, we export tons of agricultural products.

looking for that pick-me-up to power through an all-nighter?
 

What do you guys think of some of the predictions of where gold is heading? Paulson is predicting $4000 by 2013-2014? But more of the short term, do you guys think some of the estimates on the size of QE2 is way blown over, as GS predicted up to 1 trillion in bond purchases while much more conservative numbers are between 200-250 billion? Im assuming the current rally in gold and its price will fall back if the Fed does announce a smaller than expected QE?

 
Best Response

the purpose of QE is to lower REAL interest rates. There are two ways to do this: 1) lower nominal interest rates 2) stoke inflation. Since nominal interest rates are already very low and rates cannot really go through 0 (since people would just prefer cash), the Fed is now hoping to increase inflation through another round of QE.

So I dont think the actual purpose of QE is to debase the ccy, but a lower currency is indeed a symptom of their possible success in creating inflation (or staving off deflation).

As an editorial aside, I would also note that for the last decade the Fed has had a perfect record of being dead wrong at the turn of cycles. In 2003 they were pounding the table about deflation as the housing bubbles was forming. In 2006-2007 they were saying housing was "contained" and that inflation was a worry...we know how that ended. In 2010 they say deflation is a great risk and more easing is needed. I am placing my bets that the fed is wrong again and that the economy is fine and deflation is not the bogey-man they think it is....we'll see.

 
Bondarb:
the purpose of QE is to lower REAL interest rates. There are two ways to do this: 1) lower nominal interest rates 2) stoke inflation. Since nominal interest rates are already very low and rates cannot really go through 0 (since people would just prefer cash), the Fed is now hoping to increase inflation through another round of QE.

So I dont think the actual purpose of QE is to debase the ccy, but a lower currency is indeed a symptom of their possible success in creating inflation (or staving off deflation).

As an editorial aside, I would also note that for the last decade the Fed has had a perfect record of being dead wrong at the turn of cycles. In 2003 they were pounding the table about deflation as the housing bubbles was forming. In 2006-2007 they were saying housing was "contained" and that inflation was a worry...we know how that ended. In 2010 they say deflation is a great risk and more easing is needed. I am placing my bets that the fed is wrong again and that the economy is fine and deflation is not the bogey-man they think it is....we'll see.

Im going to take the other side of your bet (kind of) and say the Fed is right about its deflation forecast, but there is not a damn thing they can do to stop it since there will be continued deflationary pressure from deleveraging consumers. Either way, the Fed's policy tools will either be wrong or futile, and this is where I add my disclaimer that I never have anything nice to say about the Fed, particularly the current state of affairs with Benny and the Inkjets.

 

While debasing the dollar might factor into the reasoning behind QE2, I think it's also a political calculation. Officials have been talking about the need to prop up asset prices and QE2 is the perfect way to do that in nominal terms. The hope is that people who consider equity markets to be a barometer for the wider economy will vote for incumbents since their retirement savings keep growing (although only in nominal terms). Since most commodity prices don't directly factor into the CPI, it could be a while before people actually realize what's going on.

 
walkio:
How exactly does higher inflation lower interest rates and therefore causing a lowering of the currency? (Sorry, am a non-Economics major).

If US interest rates are low, people will shift out of the dollar into higher-yielding currencies. As demand for the dollar decreases, its exchange rate falls. Higher inflation is a byproduct of the system's increased liquidity when rates are low. Since more dollars are chasing the same assets, prices go up. High inflation also implies that the dollar is able to buy less and less and therefore that the exchange rate should weaken.

 

Are we even going to see that drastic of an increase in inflation? It seems as if the only area that is going to get hit the hardest is commodities. Oil is going to shoot up along with other materials. The fact is that US factories are already producing way below their capacity. The increase in demand is not going to be so great that prices of goods other than commodities are going to skyrocket.

 
E46fan91:
Are we even going to see that drastic of an increase in inflation? It seems as if the only area that is going to get hit the hardest is commodities. Oil is going to shoot up along with other materials. The fact is that US factories are already producing way below their capacity. The increase in demand is not going to be so great that prices of goods other than commodities are going to skyrocket.

Inflation isnt only a product of changes in supply and demand of goods, but also the supply and demand of money. Since the US FED has been printing money to stimulate the economy there could in the future be an excess supply of money if banks start lending it and consumers are confident in spending it.

Whether this will happen or not depends on if the FED can extract the money from the system effectively via Repo's and what not. Theoretically only unexpected inflation is really dangerous (usually caused by supply and demand shocks) whereas changes in the money supply are mostly expected inflation and thus can be forecasted and adjusted for. Many believe that there is too much money out there and in foreign hands to be just bought back by the Fed when they want to adjust the supply of money and reign in inflation. PIMCO is a good firm to watch on this, they were ahead of the curve in buying TIPS, and were really quick to get out once they realized that deflation was still a concern.

 

Well, inflation could also happen when the supply of money increases. If production in an economy increases because of the increased money supply, the value of a unit of currency may also increase, even though there is more currency available. For example, if a nation's economy were to spur a significant increase in output at a rate at least as high as the amount of debt monetized, the inflationary pressures would be equalized. This can only happen if member banks actually lend the excess money out instead of hoarding the extra cash.

But the problem is, now the banks are sitting on nearly a trillion of excess reserves while there is little loan demand right there. So inflation happens now when the QE3 is ineffective anymore. So U.S. FED is planning to decrease the QE program and makes some specific adjustment.

 

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