Tuesday, November 2nd, 2010
The new buzzwords – Quantitative Easing – have been added to the alphabet soup of remedies for our still ailing economy. The quick fix “QE” recipe consists of the Fed buying bonds and flooding the economy with the proceeds in the hope that more money will inspire the recipients to spend the dough and thus get the economy off its rump.
But will this round of quantitative easing achieve the desired result?
First, the problem with our economy at this time is one of demand – there is not enough final demand for goods and services. The consumer, the primary driver of demand, is a wary buyer these days and for good reason. Unemployment is high and seems to be stuck there. That does not inspire confidence in spending even if one has a job, particularly with all the headline news about Governments – Federal, state and local – needing to cut back spending, which means laying off employees or foregoing projects.
Secondly, consumers are still engaged in the process of trying to pay down their own already too high levels of debt. While the numbers show some good progress on that score, both with regard to credit card debt and mortgage refinancing that is taking advantage of the lowest rates in half a century, consumers’ balance sheets are still far from secure.
So who will be the beneficiaries of this impending QE?
It seems to me that first and foremost it will benefit the big banks and financial institutions, including hedge funds, which have already benefitted handsomely for two years under the easy money policy of the Federal Reserve. For the lending institutions, the wider the spread between their borrowing costs and the interest rate they can charge on loans, the more profitable they are. Admittedly, many of the large banks still need desperately to continue to improve their own balance sheets, and if that were the only objective of the Fed, QEII would be a good idea.
As for the hedge funds, there is no dearth of nearly free money for them to leverage into gargantuan profits. But that provides little stimulus for the economy as a whole.
There is nothing inherently wrong with either banks or hedge funds benefitting from QEII, but that won’t bring the consumer into the business of spending, which must take place in order to goose this slack economy.
The stock market will likely respond favorably to QEII. In fact, one might argue it has already discounted some of the incremental money that will flood the system. One might argue, too, that is good for the consumer, and it certainly will help rebuild the devastated 401(k) plans of many working Americans. But unlike the era of the 1990s when consumers spent freely as they watched the assessed value of their house and the market value of their retirement accounts rise, this time I believe consumers will be careful not to return to their old spending ways. Instead they will take heart from any improvement in the value of their assets and will safeguard their nest egg.
Unfortunately for consumers, the easy money will have little if any positive impact on the usurious rates on their credit card debt. Despite the law passed earlier this year which provides some new protections, it does nothing to lower existing rates for past debt, rates that in many cases are well over 20%. That is a serious impediment to growth, because existing credit card debt is an economic millstone around consumers’ necks.
QEII will allow large corporations, which undeniably comprise the healthiest sector of our economy, to finance long term projects at very favorable rates. This is good news as it will add to productivity and corporate earnings. But it will do nothing to stimulate consumer demand or add to jobs.
The banks remain tightfisted in lending to small businesses. Until and unless the money spigot opens up to that all-important sector of the economy, the sector that in fact creates the large majority of new jobs, QE II will not spark growth.