For people who are legally subjects of Her Britannic Majesty, the abbreviation QE2 is understood as shorthand for Queen Elizabeth the Second, the current reigning monarch of the United Kingdom. For most others, the term brings to mind the great ocean liner, launched by and named after Her Majesty and the flagship of the Cunard Line for many years (and today permanently docked in Dubai – sic transit gloria!).
But the QE2 referred to here has nothing to do with either of the above. QE is the abbreviation for “quantitative easing”, a term in use since the crisis of 2008/09 to describe a particular and peculiar form of monetary policy. Even economic illiterates will know that monetary policy is what central banks indulge in, and centers on raising or lowering interest rates. Raising rates is called tightening, because it takes money out of the system and lowering rates is called loosening, because it puts more money into the system, thereby “increasing liquidity”).
The problem facing the US central bank, the Federal Reserve, in early 2009 was that it had cut interest rates almost to the ‘lower bound’ of zero. In practice, nominal interest rates cannot be negative, because nobody will lend you money and pay you for the honour as well. However, the Fed wanted to loosen monetary policy further, to provide additional liquidity and hence stimulus to the crisis-stricken and semi-paralysed economy. It therefore adopted a highly unorthodox policy of buying long-term bonds in the market on its own account, paying for them by simply creating money out of thin air. This approach would normally be inflationary and hence completely verboten, but in extreme circumstances, extreme measures are necessary – or so the Fed explained its move.
In the course of a year or so, the Fed bought US Treasury bonds and agency-issued mortgage-backed bonds to the tune of some $1.25 trillion. Supporters of QE credit it with having stabilised the financial markets and got the system functioning again, thereby allowing the economy to rebound from the sharp recession that began in December 2007. Others are unconvinced that QE played a major role, or say that the price paid – effectively allowing the Fed to print money with which to buy debt and thereby indirectly finance Uncle Sam’s huge budget deficit – is unacceptably high.
The recovery that began in spring 2009 faded during 2010 as the impact of the stimulus programs wore off. This sparked the idea to launch QE2 was born – another massive round of bond buying by the Fed, to provide the additional stimulus it was claimed would prevent the dreaded ‘double-dip’. Buying long-term bonds would push their prices up and hence their yields down, and low yields or interest rates on long-term loans such as mortgages would help revive the housing sector and would spur corporations to invest, thereby creating jobs, etc.
It is now almost certain that the Fed will provide long-awaited details of its QE2 program at its meeting next Wednesday, November 3. Not coincidentally, this is precisely one day after the mid-term elections, which are expected to result in strong Republican gains and thus in a Congress opposed to further fiscal stimulus via increased government spending. The assumption is that the Fed will announce a program of gradual purchases of some $100 billion per month, with could be increased or decreased in line with developments in the economy. The widespread expectation of this move since Fed Chairman Bernanke first signaled it in late August is the primary factor behind the surge in share, bond and commodity prices, and the fall in the value of the US dollar versus other currencies, since then.
However, there has also developed a large and growing opposition to QE2, which encompasses several Governors of regional Federal Reserve Banks and a slew of prominent economists. Their main arguments are two-fold. First, QE2 is unlikely to achieve its declared goal; simply put, if pumping money into a comatose economy is like pushing on a piece of string, then pushing harder with two fingers is not going to help. Secondly, even if the policy does spur economic activity, this will be a temporary and artificial boost, while its legacy will be a lasting and massive increase in government debt.
The argument is heating up steadily and is now the central issue in the global economy. One of the most powerful voices to come out in strident opposition to QE2 is Bill Gross, founder and co-chief investment officer of PIMCO, the largest bond-fund management company in the world. In his November ‘Investment Outlook’ (available at the PIMCO site www.pimco.com/Pages/InvestmentOutlookOverview,aspx ) Gross describes QE2 as the most brazen Ponzi scheme of all time. Highly recommended reading , but you need a strong stomach.