Treece: Why QE3 is destined for failureWritten by Ben Treece | | email@example.com
In the minutes from the Federal Reserve Board meeting on Tuesday, we learned that, against the will of many FRB members, the Fed is considering more quantitative easing. We have written and commented before on why this policy just does not work, and we stand by that statement. This will be the third round of QE that has been imposed since the financial crisis of 2008 over the course of two separate administrations, yet we still have yet to see a significant economic recovery. In our opinion, QE policies have been one of a myriad reasons why the economy has yet to turn around significantly.
Quantitative easing is defined as increasing the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. This can be done in several ways, whether it is putting money straight into the pockets of citizens as President Bush did in 2008, or by printing money and funneling it to lending institutions through either loan programs or the purchase of securities from those institutions as President Obama did in 2010. Either way, the idea is to supply the market with capital that can be spent on projects or consumer goods. What some economists and many politicians fail to realize is that there are more downsides to quantitative easing than good.
If QE were the end-all answer, we would not be seeing the measly 1 percent to 3 percent gross domestic product growth that we have been seeing since 2010. We should be seeing Reagan-era 7 percent to 10 percent growth, but the current administration simply cannot get a grasp on this haltered economy. The fact is that QE will provide a brief jolt to the economy, but nothing that will sustain or be substantial to growth. Imagine that I gave you $100 today; does that mean that you’re going to spend $100 every month for the next year? That is the basic logic behind QE: More money in your pocket today GUARANTEES sustained long-term spending. This is clearly not a logical statement.
Another downside of QE is that it can lead to inflation. More currency in the economy means a less valuable dollar, it is truly that simple. Many figureheads will have you think that monetary policy is much more complex than that simple description. In reality their explanations are all smoke and mirrors. A common argument is that QE does not lead to inflation since we have seen no substantial impact on the U.S. dollar’s value since QE2. However, as Dock David pointed out in “Ingredients for Inflation,” M3 (money supply) has actually been decreasing and inflation has not been realized due to the lack of velocity (money turning over in the economy). This cash is literally sitting at lending institutions waiting to be loaned out in a market where nobody is borrowing.
One question that nobody seems to ask regarding QE is where the money comes from? The easy answer is from the government, but let’s think about this realistically. How can a federal government that currently has no budget in place and is running massive deficits afford to supply more capital to the markets? As we mentioned before, one way could be through the printing of new currency, but this could lead to an inflated dollar, which would be catastrophic for a recovering economy. Another way is through spending by increasing government revenue … also known as hiking taxes. The final way is through debt financing, or the selling of government bonds. These three options for obtaining capital would all ultimately result in economic hardship.
If the Treasury prints new money, we will eventually face drastic inflation if economic growth does not keep up. This will hurt consumers’ pocketbooks and result in a decrease in discretionary spending. The current administration cannot in any way justify hiking taxes, even on corporations and high earners. These are the people who are able to hire and who are out spending money and driving the economy while the rest of America tightens up their finances. Having them pay their “fair share” would result in more jobs lost due to decreasing corporate after-tax revenues and thus fewer dollars to spend for both top earners and Main Street employees who will have lost their jobs due to downsizing. Lastly, the federal government cannot possibly consider financing this venture through debt for many reasons. First of all, nobody in their right mind wants to buy bonds with interest rates as low as they are right now. Secondly, the current administration is already taking flak for its willingness to run up a massive deficit. Borrowing more money (likely from sources abroad) would not sit well with most Americans, something the administration is keeping in mind going in to an election year.
The answer is a simple one that I wrote about in my article “Economics 101: Common Sense” — we must cut taxes. Cutting taxes across the board would result in more money available for households to pay down debt and for discretionary spending while simultaneously allowing for corporations to hire new employees without the fear of hurting their bottom line. It truly is a simple answer, but instead of putting full faith in a tried and tested method, the Fed has shown that they are willing to engage in a policy which has failed twice over now. This is the definition of insanity; repeating the same action over and over and expecting to yield different results.
Ben Treece is a 2009 graduate from the University of Miami (Fla.) with a bachelor of business administration degree in international finance and marketing. He is a partner with Treece Investment Advisory Corp (www.TreeceInvestments.com) and a stockbroker licensed with FINRA, working for Treece Financial Services Corp. The above information is the express opinion of Ben Treece and should not be construed as investment advice or used without outside verification.