A dialogue on Quantitative Easing

In a facebook discussion:

Right wing, nitwit Brother in law says:

Do you realize that California is paying out $40,000,000 a day in unemployment benefits and since they are broke, that means you and I are paying this……oh wait, we (the feds) are broke too………..ok….print more money………wait…….won’t that lead to inflation?

Financial Services insider cousin says:

Nope. It won’t lead to inflation. Well not much anyway. Maybe a percentage point or two if we are lucky – because thats the point. When interest rates are at the zero bound, as economists say it is the equivalent of “pushing on a string”…. You try and pump the economy with fiscal policy but nothing happens because people save their money and banks wont lend so the money just sits there. Normally the fed would just cut interest rates now, but as they are at zero – they can’t. Thus Quantitative easing. Not a cure all – but it might help at the margins. That’s why there is an argument for temporary government spending, which would help. But there is zero appetite for more spending, so the Fed is the next best alternative.

Think of it this way – is our debt easier to pay off with inflation or deflation? Answer: inflation. And deflation is the Fed’s biggest fear right now. See 1930’s America and Japan today for reasons why.

While cutting spending and having the government tighten it’s belt and reduce debt sounds great – it really does – almost all evidence in economic history says that it would only make the economy worse when we are on the verge of deflation. Cutting debt and spending makes lots of sense when the economy is growing and we have slight inflation.

The ideal thing would be to get the economy recovered first. THEN cut government spending.

The real fear with QE2 is that it won’t do enough and the economy will stay in the doldrums. In fact, that’s what most economists think will happen.

So don’t worry about hyperinflation. It ain’t happening.

OK, the quantitative easing economics thing is something I’ve commented upon, which tempts me to want to respond on the facebook post, but I’d prefer not to deal with RWNBIL.  I will begin with where I am in agreement with FSI cousin which is  “The real fear with QE2 is that it won’t do enough and the economy will stay in the doldrums. In fact, that’s what most economists think will happen.”  I mentioned in the the quantitative easing post that “economists over at Goldman Sachs estimate that it would take a staggering $4 trillion in quantitative easing to get the economy rolling again”, which is a note that FSI insider is one of those economists. I also said that “quantitative easing can lead to serious hyperinflation and that the cycle of debt needs to come to an end”

Note that I said can not will.

That is an important distinction since unless we are talking about the $4 trillion in quantitative easing, we probably won’t see hyperinflation.  Still, the point is that quantitative easing is not the optimum solution: it is the ultimate last ditch.  It is screaming “uncle”.

World opinion to QE2 is negative and in some ways ironic: e.g., The Chinese chastised the US for QE2 at the G20.  The Irony being that the Chinese Yuan is the usual suspect in currency diddling for being undervalued. Now, the Chinese have turned the tables and are accusing the US of the same thing the Chinese are usually accused of doing.

The real beef with FSI cousin is that he is one of the beneficiaries of Quantitative Easing since the eased “money” goes to the financial services industry, not the people who are in debt.  My previous quantitative easing post was a bit simplistic in how it addressed this issue prefering to let the video describe the practise. Likewise, I will let this video explain fractional reserve banking:

The current economic system is based upon debt. If you consider that fractional reserve banking is based upon debt and that quantitative easing means that the banks will be able to increase their “reserves”. The problem is that the people who really need money are not the beneficiaries of the quantitative easing. That means the economy will stagnate and we will see our standard of living drop.

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