Tuesday, November 02, 2010

QE2 or Titanic?

Or both ?

The Titanic, of course, was dubbed "the safest ship ever built".
She was touted as the safest ship ever built, so safe that she carried only 20 lifeboats - enough to provide accommodation for only half her 2,200 passengers and crew. This discrepancy rested on the belief that since the ship's construction made her "unsinkable," her lifeboats were necessary only to rescue survivors of other sinking ships. Additionally, lifeboats took up valuable deck space.

The QE2 is also a bit of a legend, dubbed "the greatest ship the world has ever known". She is now a drydocked hotel-in-waiting, intended to service the Palm Jumeirah in Dubai in another display of the Encore of Excess. She is owned by Nakheel, the Dubai company. Remember Nakheel?

Both ships serve as sort of a metaphor for the Monitization of Debt policy of the US Federal Reserve Board, which is expected to be revealed real soon like. Some folk are referring to it as a sort of Corruption of the Currency.

When Guambat thinks about it, he thinks of those glorious times back some fifty plus years ago in middle school days when he got a goody-two-shoes job in the Principal's office, which quarantined him from the boring class room. The job: running the mimeograph machine, cranking away while getting high and giddy on the addictive smell of the copier chemicals.

Guambat reckons Mr. Bernanke shares a similar addiction. Having run off 1.5 Thrillion dollars just a year ago, he's cranking up to run off another half to one more Thrillion more.

The Joys and Horrors Of QE2 (commentary by Dan Dorfman)
In football, they call it a Hail Mary Pass -- a last-minute act of desperation in which a quarterback throws a very long forward pass which has only a minimal chance of success.

That's essentially how economist Madeline Schnapp of West Coast liquidity tracker TrimTabs Research, partially owned by Goldman Sachs, views the widely expected second round of quantitative easing, or, as it's called, QE2.

What excites so many people is that QE2 is supposed to be a significant economic booster. In brief, the Federal Reserve prints money, which is used to buy long-term debt from banks that gives them more capital to lend and lower interest rates. In turn, that injection of this liquidity supposedly will goose the economy, stimulating more job creations, more housing sales and higher wages and salaries.

The QE2 program -- estimated at between $500 billion $1 trillion -- is expected to be announced November 3 at the Fed's Federal Open Market Committee meeting.

The first such easing, QE1, an estimated $1.5 trillion, took place in March of last year. As you can tell by the ongoing sluggishness of the economy, it has hardly been a bell-ringer.

Fed Policy Generates Sharp Divisions
Proponents say buying hundreds of billions of dollars more in Treasury bonds will provide only modest support for the economy. Foes warn that it could backfire by pushing up commodity prices, sowing seeds of unwelcome inflation in the future, or by undermining confidence in the Fed's ability to manage—and eventually reduce—its holdings.

Opponents stretch across the ideological spectrum, from John Taylor, a Stanford University economist and former Bush Treasury official, to Joseph Stiglitz, the Columbia University Nobel laureate and former Clinton White House official. Mr. Taylor has said the effort, known as quantitative easing, or QE, won't work, and that the government instead should avoid raising taxes and stop imposing new regulations. Mr. Stiglitz has said QE won't work and that the economy needs a big dose of spending increases and tax cuts.

Economists don't even agree on what another round of quantitative easing would do. Bank of America Merrill Lynch expects it should help push the 10-year Treasury yield to around 2% late this year from 2.63% today. Mizuho Securities says the effect of any new asset purchases "will be limited."

In a Dow Jones Newswires survey of firms that trade directly with the Fed, economists from Nomura Securities International Inc. said another round of QE would maintain "consumer confidence on track to keep the recovery ongoing." UBS said it would help only "modestly." Deutsche Bank said purchases could hurt the economy if they push the dollar down too far.

In its first bond-buying program, which ended in the spring, the Fed bought $1.75 trillion of mortgage-backed securities and Treasurys. The move, during severe stress in financial markets, is credited with helping to pull the economy out of its downward spiral. If the Fed could cut short-term interest rates, its traditional tool, it would. But short-term rates are near zero so it is seeking an alternative strategy.

QE2 risks currency wars and the end of dollar hegemony
The Fed's "QE2" risks accelerating the demise of the dollar-based currency system, perhaps leading to an unstable tripod with the euro and yuan, or a hybrid gold standard, or a multi-metal "bancor" along lines proposed by John Maynard Keynes in the 1940s.

China's commerce ministry fired an irate broadside against Washington on Monday. "The continued and drastic US dollar depreciation recently has led countries including Japan, South Korea, and Thailand to intervene in the currency market, intensifying a 'currency war'. In the mid-term, the US dollar will continue to weaken and gaming between major currencies will escalate," it said.

Pious words from G20 summit of finance ministers last month calling for the world to "refrain" from pursuing trade advantage through devaluation seem most honoured in the breach.

"It is becoming harder to mop up the liquidity flowing into these countries," said Neil Mellor, of the Bank of New York Mellon. "We fully expect more central banks to impose capital controls over the next couple of months. That is the world we live in," he said. Globalisation is unravelling before our eyes.

Each case is different. For the 40-odd countries pegged to the dollar or closely linked by a "dirty float", the Fed's lax policy is causing havoc. They are importing a monetary policy that is far too loose for the needs of fast-growing economies. What was intended to be an anchor of stability has become a danger.

Hong Kong's dollar peg, dating back to the 1960s, makes it almost impossible to check a wild credit boom. House prices have risen 50pc since January 2009, despite draconian curbs on mortgages. Barclays Capital said Hong Kong may switch to a yuan peg within two years.

As this anti-dollar revolt gathers momentum worldwide, the US risks losing its "exorbitant privilege" of currency hegemony – to use the term of Charles de Gaulle.

The innocent bystanders caught in the crossfire of Fed policy are poor countries such as India, where primary goods make up 60pc of the price index and food inflation is now running at 14pc. It is hard to gauge the impact of a falling dollar on commodities, but the pattern in mid-2008 was that it led to oil, metal, and grain price rises with multiple leverage. The core victims were the poorest food-importing countries in Africa and South Asia. Tell them that QE2 brings good news.

It may be instructive to read up on the debate whether, or to what extent, global protectionist measures causes or potentiated the Great Depression.

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