The economy, insanity and QE3

QE3 is not the name for a yet-to-be-commissioned cruise ship. It’s shorthand for “quantitative easement-3,” which is a nice way of saying, “We’re gonna print some more money, folks, and this is the third time we’re doing it.”

Governments have two methods of regulating their countries’ economy: fiscal policy and monetary policy.

Stripped to its essentials, fiscal policy amounts to how the government taxes and spends. We can forget about fiscal policy for the moment — the House, Senate and president are all standing around with arms folded as they eye one another with suspicion. That leaves only monetary policy.

Monetary policy regulates the economy by setting interest rates and controlling the supply of money. If, for example, we experience a period of high inflation, the Federal Open Market Committee may raise interest rates as a way of putting on the brakes. If, however, we’re experiencing high unemployment and a sluggish economy, as we are now, it may want to lower interest rates to encourage spending and boost the economy. And therein lies the rub.

Interest rates are already at essentially zero, and have been for a long time. So what then? That’s where quantitative easement comes into play. On Thursday, Federal Reserve Chairman Ben Bernanke announced that the Fed would begin buying back mortgage-backed securities at the rate of $40 billion per month with no anticipated cutoff.

Normally, interest rates will control the nation’s money supply. As interest rates rise, the money supply naturally shrinks. If the Fed lowers interest rates, the money supply will naturally increase. In this instance, the Fed is artificially increasing the money supply by monetizing our debt.

Has it tried this before? You bet — twice. That’s why it’s called “QE3.”

Did it work before? Nope!

Then why does the Fed think it will work this time? At this point, it would be tempting to discuss Einstein’s oft-quoted definition of insanity — doing the same thing over and over again and expecting different results. But that would be way too easy.

QE 1 and 2 were limited to dollar amounts, totaling $2 trillion for the two together. Not much of a limit, I know. This time, the Fed’s securities purchases are open-ended. Although limited to $40 billion per month, there’s no set cutoff, and the Fed is prepared to go on forever with this until it gets the result it wants.

Typically, debt monetization — paying off debt with printed money — results in hyperinflation. We all remember those photos from Germany’s Weimar Republic where the husband carted a wheelbarrow of money into the bakery to buy a loaf of bread, while the wife sat at home feeding stacks of cash into the stove to heat the house.

It all makes perfect sense. As the money supply is increased, each dollar is worth less, so it takes more to purchase our goods and services. Although we’ve all been feeling the pinch of inflation, according to New York Fed President William Dudley, it’s all an illusion. He argued last year that inflation doesn’t exist because the iPad 2 costs the same as the original iPad. Argh!

Thankfully, not everyone associated with the Federal Reserve System is living in an alternate universe. Richmond Fed President Jeffrey Lacker thinks QE3 is a horrible idea. For that matter, so does the bond-rating agency Egan-Jones. As a result of Bernanke’s QE3 announcement, Egan-Jonesdowngraded our national creditworthiness from AA to AA-.

If you’re still confused about QE3, perhaps the following video may help. It’s a few years old, but its humor befits the insanity of the situation.
[youtube_sc url= w=”425″ h=”349″] 

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