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There has been so much discussion
recently about "QE 2" that you would think the entire financial
sector were about to embark on a transatlantic cruise. Unfortunately, they,
and we, are not so lucky. In the year 2010, "QE 2" doesn’t refer
to a sumptuous ocean liner, but a second, more extravagant round of
"quantitative easing" – stimulus. In the past, this technique
was simply called "printing money." As if the nation has not
already suffered enough from the first round, Captain Ben Bernanke and the
Fed are determined to compound the damage by hitting us with another monetary
juggernaut. Their stated goal is to boost the economy and create jobs.
However, since economic growth cannot be achieved by printing money,
their QE 2 will sink just as surely as the Titanic.
The intent of QE 2 is to lower
interest rates to promote job growth and avoid the apparently growing threat
of deflation. But the very idea that the economy is weak because interest
rates are too high is laughable. Deflation is the market's cure for the asset
bubbles that have recently burst, so any attempt to avert it will only weaken
the economy further.
In fact, one of the reasons the US
economy is in such bad shape is that interest rates are already too low. Low
rates have encouraged excess borrowing, by both individuals and governments,
and discouraged saving, fueling new asset bubbles at the expense of
legitimate investment. As a result, the dead weight of debt has simply
overloaded our economy, and our creditors are getting nervous. What we need
now is to make hard choices, not engage in more easing – to deleverage,
not borrow more.
Worse still, by keeping rates too
low, the Fed has enabled the US government to grow significantly larger than
it otherwise could had its borrowing been restrained
by higher rates. Absent these low rates, Washington likely wouldn't have
passed expensive new healthcare and financial regulation reforms; they would
be too busy trying to keep the lights on in the Capitol.
For this and other reasons, the
bogeyman of deflation is really not a concern at all. It's not a threat
because falling consumer prices could serve as a relief for many suffering
from layoffs and pay cuts in the recession. Even if it were a threat, it's
not even likely because so much liquidity has already been created and an
infinite amount could still be created at will by the Fed. Consumer prices
are already rising across the board, despite a contracting economy, so what's
all this talk about deflation?
The Fed is quick to point to
falling real estate prices. But a drop in real estate will no more cause
consumer prices to fall than the real estate boom caused them to rise. Real
estate prices are too high, and the economy will never truly recover unless
they are allowed to fall. It is interesting that when real estate prices were
rising, the Fed did not raise rates to bring them down, but now that they are
falling, the central bank feels compelled to lower rates to prop them up. If falling
real estate prices threaten deflation, why did the Fed not
perceive an inflation threat when real estate prices were rising?
My thinking is that, at the end of
the day, all this deflation talk is a red herring. The true purpose of QE 2
is to disguise the decreasing ability of the Treasury to finance its debts.
As global demand for dollar-denominated debt falls, the Fed is looking for an
excuse to pick up the slack. By announcing QE 2, it can monetize government
debt without the markets perceiving a funding problem. If the truth were
known, a real panic would ensue. So, the Fed pretends buying treasuries is
simply part of its master plan to boost the economy, even though, in reality,
it is simply acting as the buyer of last resort.
If the Fed really wanted to help
the economy, it would raise rates quite dramatically. Instead of preparing
for QE 2, it should be unloading the debt it purchased during QE 1. Of
course, that is not so easy to do – which is precisely why I was
against QE 1 from the beginning. However, even though the exit will be painful,
going down with the ship will be even more unpleasant.
Higher interest rates and a
commitment from the Fed to refrain from purchasing Treasury debt would force
the government to dramatically reduce spending. If we combine less government
spending with fewer regulations, reform our tax code in a way that stops
punishing savings and investment, stop all government subsidies for real
estate so that prices can fall to affordable levels, and allow all insolvent
entities to fail, then a real recovery will take hold.
If the Fed refuses to set sail on
QE 2, then her loyal passengers might complain, but at least the US will be
on solid monetary ground as it tried to rebuild a viable economy. If instead
we board QE 2 (and QE 3 and QE 4 thereafter), then we are headed to a sea
full of icebergs called interest rate spikes, and all on board will surely
drown in a sea of worthless Federal Reserve Notes.
Peter D. Schiff
President/Chief Global Strategist
Euro Pacific Capital, Inc.
20271 Acacia Street, #200 Newport Beach,
CA 92660
Toll-free: 888-377-3722 / Direct:
203-972-9300 Fax: 949-863-7100
www.europac.net
pschiff@europac.net
For a more in depth analysis of the tenuous position of the American
economy, the housing and mortgage markets, and U.S. dollar denominated
investments, read my new book : The Little Book of Bull Moves in Bear Markets" (Wiley, 2008).
More importantly
take action to protect your wealth and preserve your purchasing power before
it’s too late. Protect your wealth and preserve your purchasing power
before it’s too late. Discover the best way to buy gold at www.goldyoucanfold.com , download my free
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