By: John W. Schoen
December 14, 2010
Central bankers meet Tuesday to decide whether to print even more money
How much government money will it take to get the U.S. economy moving again? As Federal Reserve officials meet this week to ponder their latest "pump priming" efforts, a recent rise in interest rates presents them with a sobering prospect.
Maybe running the money printing presses flat out just isn't working. And won't work no matter how much money the central bank creates out of thin air.
The strategy is officially called "quantitative easing," and while the Fed isn't actually printing money, it is trying to make money cheap enough to get the economy moving again. After lowering short-term interest rates to zero, the central bank has embarked on a huge government bond buying spree -- some $2 trillion worth since the credit markets melted down in 2008. Last month, the Fed announced a new $600 billion round of bond buying, dubbed "QE 2," in an effort to speed up a recovery that has so far failed to dent a 9.8 percent unemployment rate.
The two-year-old policy has never been tried in the central bank's 97-year-history. The hope is that lower interest rates will make it easier for companies and consumers to borrow, spur spending and investment, and boost economic demand and create new jobs.
But so far, the impact of the Fed's latest bond buying spree isn't promising. After bottoming in October, mortgage rates have moved steadily higher, rising by half a percentage point since October. On Monday, rates on 10-year U.S. Treasuries continued to advance a six-month climb, striking 4.61 percent for a 30-year mortgage, up from 4.46 percent the week before.
Critics say the rise shows that the Fed's plan to spur the economy by lowering rates with massive bond buybacks is backfiring: interest rates are going up and the jobless rate isn't going down.
"They've gotten the opposite results," said Stephen Roach, non-executive chairman of Morgan Stanley, Asia. 'If anything that takes a little bit out of economic growth instead of adding to it. The markets are rendering a very negative verdict on the Fed's grand experiment."
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The Fed itself is not unanimously in favor of the idea of flooding the system with money. During the run-up to the latest "quantatative easing" announcement last month, Kansas City Fed President Thomas Hoenig warned of the risks of higher inflation and the formation of another bubble like the housing market that precipitated the 2008 credit crash.
"I worry that by pumping in significant amounts of dollars we then build the inflationary pressures for the future," he said. "And we do encourage then an easier credit environment that helped create this problem in the first place."
The recently unveiled Obama administration-congressional Republican tax plan also dealt a setback to the Fed's strategy. Just weeks after the Fed pledged to buy $600 billion in bonds, the tax compromise added $900 billion in new bond sales to pay for the plan, more than offsetting the flood of new cash. That prompted Fed Chairman Ben Bernanke to hint that the latest round of quantitative easing might not be the last.
Critics like Roach think that would just mean throwing more good money after bad.
"Why haven't we tried to unclog the system of credit and get that first QE money in the hands of small and medium sized business who are desperate for credit and who do the bulk of hiring and can make a difference to Americans?" he said. "I just think we're going about this completely the wrong way."
Defenders of the Fed's historic spree of bond-buying say it helped prevent a much wider financial meltdown and has helped get the economy back on track. To be sure, many economists have recently upgraded their growth forecasts for next year. But many credit the stimulative effect of planned tax cuts and extended unemployment benefits, not the Fed's easy money policy.
The prolonged use of printed money to buy more government debt may drive up the cost of borrowing faster than the Fed can try to rein it in. As worries rise about the government's ability to pay back all this debt, so too does the return that bond investors demand to cover the increased risk.
Credit rating agency Moody's highlighted those fears Monday by warning that if the proposed tax plan is approved, Moody's could move a step closer to cutting the U.S. government's top-notch Aaa credit rating. The lower the credit rating, the more companies and governments typically have to pay to attract investors to buy their bonds.
The Fed's plan has also hit another major snag: much of the nearly $2 trillion the central bank has printed since the start of the financial crisis simply isn't getting where it's supposed to go -- to households and the small businesses that account for more than half of all new jobs. Bankers complain that in such a weak economy, there isn't enough demand for loans; borrowers say banks are being too picky about to whom they lend.
For whatever reason, lending to U.S. small businesses continued to drop in the third quarter, by $163 billion, the seventh consecutive quarterly decrease, according to Fed data.
The result is a large pile of money stuck in the system. About $1 trillion of it is sitting in the Fed's vaults, stored there as "excess reserves" until bankers can find loans they want to make. Another $1.9 trillion is sitting on the balance sheets of hunkered-down American companies. That's the highest level since the Fed began keeping track of corporate cash in 1952.
While the Fed's cash flood has failed to create jobs, it is helping create wealth for some. According to the latest Fed data, the value of stocks held by American households jumped $978 billion in the third quarter.
But those gains were offset by a $747 billion loss in real estate wealth, as falling home prices continued to eat away at the biggest nest egg for most American households. So far, the Fed's easy-money policy isn't helping the dismal housing market, one of the biggest roadblocks to economic recovery.
"Owners' equity in housing is still shrinking, and it will shrink further," said Richard Berner, chief economist at Morgan Stanley. "Unless we address the problem of one in four homeowners underwater on their mortgages, housing is going to languish."
There was a small bit of good news on that front Monday when data firm CoreLogic said the number of underwater homeowners fell for the third straight quarter this summer. About 22.5 percent, or 10.8 million, of all mortgaged homes were underwater in the summer, down from 23 percent in the second quarter.