Ya gotta love them boys at the Federal Reserve (FED). Alan Greenspan gave us asset bubbles while warning about "irrational exuberance". Now, "Helicopter Ben" Bernanke gives us "unusual uncertainty" and "quantitative easing" (QE).
If you missed your class on QE, here's a crash course. It refers to a series of extraordinary measures that the FED is prepared to undertake to stimulate the economy. Bernanke earned his nickname by saying that the FED was prepared to throw money out of helicopters if that's what it took.
If the FED has been trying to inject liquidity into the system, they've done one helluva lousy job. The broadest measures of money supply, known as M2 and M3, are plunging at record rates. In fact, they are at Great Depression levels of reduction. Bernanke is an academic and a student of the Great Depression. Specifically, his interest has been to attempt to understand what went wrong. So, the helicopter plan was borne out of this knowledge, although clearly he was being figurative and not literal.
The dropping money supply, however, is probably not entirely Bernanke or the FED's fault. An uncontrollable variable, called "velocity", is providing a stiff headwind against the FED's efforts. Velocity is a measure of the rate at which money circulates. If everyone were to put their savings under the mattress, for example, velocity would be zero. On the other hand, if folks were to be engaging in a lot of transactions and borrowing to finance growth, velocity would be high.
Velocity is hard to control, since it's the result of trillions of personal decisions. It is a function of consumer and business confidence. Low confidence equals high risk aversion and no willingness to expand, therefore, low velocity.
It is believed that the FED will monetize its mortgage portfolio and use the proceeds to purchase long term U.S. Treasury Bonds. That will do absolutely NOTHING to increase velocity. In fact, interest rates are at generational lows already, and may go lower if the economic downturn intensifies as we expect. Japan, a decent analog, has sub 1% long term rates.
Using FED funds to purchase Treasury Bonds is nothing more than a monetization of the U.S. budget deficit, now running at $1.5 trillion per year.
Unfortunately, the FED is powerless. Yes, you read that right. The FED is virtually powerless. They can't reduce rates which are already near zero. Any policy moves like changing reserve requirements or Open Market Operations will have absolutely no effect in the current business climate. To be effective, the budget needs to be brought under control, jobs need to be created and confidence needs to be restored. However, none of those can happen as long as the FED is powerless to stimulate the economy. The very definition of a vicious cycle if I ever heard one.
We are facing an impending economic death sentence. The only remaining question is whether we die by lethal injection, electrocution or hanging.
On Sunday August 22nd, I would like to invite any Southern California readers to join me for an event sponored by the California Wildlife Center, called "The "Wild Brunch: Fawntasia". For more information on this organization and to purchase tickets for the event, click here http://cwcthewildbrunch12.eventbrite.com/.