QE2 timing underlines its undemocratic nature
Nov 6, 2010

QE2 timing underlines its undemocratic nature

These past midterm elections in the US saw an unprecedented in recent times republican take over in the house. Fiscal responsibility, the deficit, and opposition to stimulus were important planks in the republican and in particular tea party message. Yet mere days afterwards, the federal reserve engages in its second round of quantitative easing (printing money to buy government debt) to the tune of 600 billion dollars. While the business world was aware this move was likely - indeed it was more or less priced into the market - the topic was completely outside the elections. Interestingly, the action which is heralded as being a stimulus is contradictory to the mandate given to republicans which are stoutly against government stimulus. Furthermore,  despite its heralding by Bernanke, the major effect will be in currency not stimulus. Regardless of what one thinks about the importance of QE2, the strikingly undemocratic way it was implemented should be noted.

This is part of a larger theme where the public perception of the federal reserve and the reality are considerably at odds. It was the injections of literally trillions of dollars of liquidity by the fed and central banks around the world that provided the largest stimulus factor in preventing a crash. Programs like TARP (which projections indicate taxpayers will now lose less than 50 billion or maybe even profit on of the 700 billion invested) and stimulus were important, but not of the same scale as the Fed actions and at the very least should be considered as part of the package that includes the Fed actions. Few people know, let alone understand, the extraordinary actions of the fed; it is simply outside the discussion. From the perspective of considering its democratic (not economic) validity, knowledge of what is going on is the first step in a functioning democracy, and public knowledge is shockingly low in this area.

The Fed is, of course, not structured in a democratic way. Its role as a quasi-private, quasi-public entity means it is fairly far removed from democratic influence compared to almost any other government entity (it does get appointments from the president). However, unlike a normal publicly traded company it does not have an accountability to provide profits to a plurality of shareholders. The result is a lack of really direct influence from the masses on its actions, which coupled with a lack if media exposure about what it is doing make for a largely undemocratic system.

As for the economic merits of QE2, I think its media coverage skews the primary purpose or at least the result. The claimed idea championed is that by purchasing government bonds, interest rates will be lowered and this will encourage banks to lend more to customers, small businesses, home owners etc thus providing the stimulus effect. It will undoubtably do this to some extent, and given how the elections have removed any possibility of governmental stimulus the Fed may benevolently feel that it is up to them to be the distributors of Keynesianism. However, the evidence of the last few years is against them in that interest rates are very low, banks are flush with cash, have high reserve ratios and are simply not lending in large amounts to smaller entities like small business. M2 money (ie the money of all loans and the like created as a multiple on the base money supply as established by the Fed) has not increased with increased base or M0 injections like this one and there is little reason to expect it would be different this time round. Instead, its primary purpose is currency.

The effect of quantitative easing will be to lower the value of the US currency. Additionally, precisely as we have seen with QE1, the banks will use the money to speculate on foreign currencies which again drives the US dollar down relatively. The way it works is simple: a US bank borrows at 0%, invests in a foreign currency bond at >0% and nets the difference. It is inflationary with regards to the capital of banks, but because it doesn't add to the money supply available for consumers it may well even be slightly deflationary for CPI.

Having a low currency is beneficial to exports (and detrimental to imports) but because jobs are tied to exports, worldwide this is the key factor people worry about. Globally, currency wars are increasing in heat and prevalence; it is a race to the bottom. Whoever has the lowest currency has the most competitive advantage on exports and we are seeing efforts to lower currencies from countries around the world. The Chinese are artificially keeping their currency low to be competitive and US pressure on them to allow their currency to rise is part of the same idea of a relative advantage. The claims of possibly labeling china as a currency manipulator in the face of quantitative easing is hypocritical at best.  Where previous trade wars have involved protectionist tarrifs on direct goods, this round of trade wars uses competitive lowering of the currencies as its chief weapon.

This issue of the major effect and arguably purpose of QE2 being misrepresented as a stimulus measure opposed to a currency measure merely underscores the opening point about the lack of a transparent and democratic federal reserve. These issues are simply too important to be outside public consciousness and influence.

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