Was QE2 Money Creation with No Negative Consequences?

Ben Bernanke says it’s all going according to plan. You see, all it took was buying government bonds with money the Fed conjured into existence.

Buy enough government debt and interest rates go down. This prevents prices from falling and sends investors fleeing from low-yielding government bonds and into stocks.

According to Mr. Bernanke all this can be done — all this new money can be created — without the old money being cheapened. An inflated money supply cures all ills with no downside.

It seems to have worked. Stocks have soared, unemployment has dropped. Americans have started to spend again.

From the Associated Press:

“The move, which began in November, was unorthodox, but the logic was simple: Buying $600 billion in Treasurys would make borrowing cheaper and move investors out of low-yielding bonds into riskier investments like stocks. A rising stock market could then give Americans confidence in the economy and spur consumer spending, which leads to higher corporate profits.

“A lot has happened in the markets and the economy since then — most of it good.

“— The unemployment rate dropped to 9 percent in January, the most recent month for which data is available. It was 9.6 percent in August.

“— The Consumer Price Index rose 0.4 percent in January and 1.6 percent over the previous year. Prices rose 0.2 percent last August from the month before and just 1.1 percent over the previous year.

“— The Standard & Poor’s 500 stock index is up 27 percent since Aug. 26, the day before Bernanke’s speech, powered by stronger corporate profits and people moving their savings into stock funds.

“— Consumer spending has climbed seven months in a row. In the last quarter of 2010, it grew at the fastest pace in three years. Spending rose 0.2 percent in January, according to data released Monday.

“‘Measured in the fairest possible way, and by just about every measure, QE2 has succeeded so far,’ says Anthony Chan, chief economist at JPMorgan’s wealth management unit. QE2 is market slang for the Fed’s quantitative easing program.”

The Fed’s prescription has been “just enough” money creation — the kind that gives the economy a boost without all the horrible side effect of price inflation.

Associated Press reports:

“‘It’s been a success,’ says Bill Gross, who manages the world’s largest mutual fund at Pimco. Gross had skewered Bernanke’s attempt to boost the economy, comparing it to a Ponzi scheme. ‘It’s hard to dispute that since Jackson Hole the market is up around 25 percent.’

“But the Fed’s $600 billion program to buy Treasurys ends in June. And Gross and other investors are concerned the stock and bond markets will fall without the Fed’s $75 billion monthly injection. ‘At the end of June, the biggest bond buyer steps away,’ he says. ‘The markets could have a shock in store.’”

Bill Gross seems to have second-guessed his Ponzi scheme accusations. But maybe he shouldn’t be so quick to eat his words.

Inflation is a process. That’s where it gets the destructive power for which it’s renowned. The very poorest and those furthest away from the new money feel it the worst.

The creator of the new money gets the most benefit. He gets to spend it first. Those who receive it next are pretty well off too. But all that new money is going to keep working its way through the system.

So while stockholders offer prayers of thanks to the Fed, others down the line don’t feel so thankful.

Take those for whom a meager portion of rice and bread represent half a daily income. A small bump in the prices of these commodities means that they are suddenly a lot poorer…and a lot hungrier.

Since the dollar is still the world’s reserve currency — and since markets are now global — money creation in the U.S. doesn’t affect the U.S. adversely at first. Instead, the misery of inflation is exported. It’s distributed to poor people in other countries first.

So things may look fine in the U.S. for now, but someone is getting the downside of this money creation right in the kisser. That does seem awfully Ponzi scheme-ish. But not so fast says Mr. Bernanke…

Again from AP:

“The Fed chief blamed the recent jump in commodity prices on droughts and severe weather that have cut supplies at the same time China’s appetite has grown. Bernanke assured Senators he would quickly tighten lending before inflation posed a threat. He said the U.S. economy still needed the Fed’s support.”

These things certainly have had an effect on food prices. China’s appetite in particular has been key to the success of Chris Mayer’s newsletters’ portfolio…

…But there’s a whiff of pure inflation-driven price increases there too. You can tell because foods aren’t the only commodities that are getting more expensive as new money is being created.

If it were just food prices, then we could chalk all this up to a richer China and inclement weather. But the signs of inflation — and its expectation — are showing up everywhere. The world’s poorest feel it most, but the middle class in the world’s richest nation are starting to feel it too. Their dollars are buying a little less food, a little less gas, a little less medical care.

Concerning the touted success of QE2, let me paraphrase a line from Harvey Keitel’s character Winston “The Wolf” Wolfe in “Pulp Fiction”:

Let’s not start shaking each other’s hands just yet, gentlemen.

Gary Gibson
Managing Editor, Whiskey & Gunpowder

March 2, 2011