News Column

What Will Happen When Quantitative Easing Ends?

June 18, 2013
dicey markets

Back in September, the Federal Reserve began its third round of quantitative easing, colloquially known as QE3, in an effort to stimulate the economy and reduce unemployment. The program started with the purchase of $40 billion of mortgage-backed securities every month, and then in December it was expanded to include an additional $45 billion in purchases of U.S. Treasury bonds every month. Thus far, the Federal Reserve has created nearly $600 billion out of thin air in a massive stimulus effort that rivals the size of the underperforming $787 billion American Recovery and Reinvestment Act of 2009, and it has achieved two particularly noticeable effects.

The first is that mortgage rates have dropped, with housing prices rising correspondingly. This is good news for those looking to refinance or to sell their houses. However, it's bad news for those looking to buy a house. The low interest rates have resulted in extremely tight lending standards, and rising prices have made it more difficult to accrue the 20 percent down payment needed to avoid the substantial monthly fees associated with FHA-insured mortgages. Housing starts have risen somewhat since QE3 began, but remain well below historical norms.

The second effect is that the stock market has skyrocketed, rising a stunning 15 percent during the six months that the Federal Reserve has been buying Treasury bonds, despite the fact that the GDP has grown only 1.2 percent during that same period. Part of this rise has been in anticipation of the economy improving, but most of it has been because there is simply nowhere else for wealthy people to invest their money. Interest rates on bonds and bank deposits have been severely depressed, and the U.S. Treasury is now borrowing only $15 billion from the public every month instead of $60 billion. And with the Federal Reserve "printing" money at such a ferocious rate, there's lots of money swirling about, waiting to be invested.

The question naturally arises: What will happen when the QE3 ends? Mortgage rates will rise, and housing prices will fall. The ability to save money with refinanced mortgages will largely vanish, and many people who bought houses during QE3 will suddenly find themselves underwater. The stock market will experience a significant decline as people pull out money to invest in renewed bond and bank deposit opportunities. The deficit will grow larger as the stock-induced surge in capital gains tax revenues dries up. And the overall economy will take a hit as the Treasury Department starts pulling a full $60 billion per month out of investors' pockets instead of the $15 billion it's borrowing today.

Should QE3 be kept going forever? No. The risks of unlimited money printing are firmly established in history. Indeed, we can expect unwanted side effects from the printing done thus far. After all, if there were no negative consequences to printing money to cover government spending, we could dispense with income and payroll taxes entirely and let the Federal Reserve cover 100percent of federal spending, instead of the 8percent it's covering today. Alas, that won't work. There's a reason we've paid taxes all our lives.

Given the economic distortions that QE3 has imposed, the almost certain pain of ceasing QE3 and the likelihood of other unintended negative consequences, another question naturally arises: Why are we doing QE3 at all?

Well, the intent was to improve the economy, but unfortunately, there has been relatively little improvement in the economic statistics that truly count. Job creation remains fairly flat, barely keeping up with population growth.

The unemployment rate remains largely unchanged. Earned wages also remain flat. Indeed, for the average American, QE3 has largely been a bust. The only people who have truly benefited are those with substantial holdings of stocks or real estate. In other words, the wealthy. If you don't own a house or lots of stocks, you've almost certainly been left behind.

There's a certain irony to this outcome. In the 2012 presidential campaign, Barack Obama castigated Mitt Romney for serving the needs of "the 1 percent" instead of the average American, but under his watch, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner have implemented a stimulus effort that has enriched the wealthy more than any other class of American.

Given how little of QE3's $600 billion has ended up in the pockets of ordinary Americans, I can only conclude that we're supposed to wait for the money to "trickle down" to the rest of us.

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Source: Copyright Roanoke Times (Roanoke, VA)

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