Introduction

Desperately ill patients are willing to try drugs that have not been shown to be either effective or
safe. Even dodgy medicines look better than the alternative. As countries’ financial systems
remain immobile in the face of standard monetary policy treatment, more are turning to
“quantitative easing” as a therapy of last resort. The US Federal Reserve is already trying it out.
The Bank of England is likely to follow. The European Central Bank probably won’t, because it
isn't sure the politicians would back it.

Quantitative easing is the modern way to print money. The central bank doesn’t actually have to
use a four-colour press to spew out crisp notes. There are more sophisticated ways to boost a
nation’s money supply. But ultimately the impact is not very different from dropping dollar bills
from a helicopter as Ben Bernanke once described this policy before he became the Federal
Reserve’s chairman.

So what exactly is quantitative easing, what disease is it supposed to cure, how is it supposed to
work and what are the possible side-effects?

The theory

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Quantitative easing is a method of boosting the money supply. Its aim is to get money flowing
around an economy when the normal process of cutting interest rates isn’t working – most
obviously when interest rates are so low that it’s impossible to cut them further.

In such a situation, it may still be possible to increase the “quantity” of money. The way to do
this is for the central bank to buy assets in exchange for money. In theory, any assets can be
bought from anybody. In practice, the focus of quantitative easing is on buying securities (like
government debt, mortgage-backed securities or even equities) from banks.

Where, one might ask, does the central bank get the money to buy all these securities? The
answer is that it just waves a magic wand and creates it. It doesn’t even need to turn on the
printing presses. It simply increases the size of banks’ accounts at the central bank. These
accounts held by ordinary banks at the central bank go by the name of “reserves”. All banks have
to hold some reserves at the central bank. But when there is quantitative easing, they build up
“excess reserves”.

If banks swap their securities for reserves, the size of their own balance sheets shrinks just as the
central bank’s balance sheet expands. Assuming they want to keep their own balance sheets
static – admittedly a big assumption in the current climate – they will then start lending to end-
borrowers and so start putting more liquidity into the economy.

To some extent, central banks have been engaging in quantitative easing for the past year. The
Fed, for example, has had a range of programmes and ad hoc initiatives that have resulted in it
acquiring securities from the banking system and more recently from the US government. The
Fed may not have justified these under the rubric of quantitative easing. But its balance sheet has
certainly mushroomed: it is up 18-fold in the past 4 months to $820bn.

Does it work?

Such quantitative easing certainly hasn’t yet done the trick so far in this recession. Credit
conditions have continued to tighten in the US. Things, of course, could have been even worse if
there hadn’t been any easing. Equally, although an 18-fold increase in the reserves on the Fed’s
balance sheet sounds impressive, it is still below 6pc of GDP. It may therefore only be once
quantitative easing properly gets going that the benefits will flow through.

Similarly, history isn’t much use in judging the therapy’s effectiveness. There has been only one
significant trial - in Japan between 2001 and 2006. Excess reserves held by banks at the Bank of
Japan rose from Y5 trillion to Y35 trillion, roughly 6pc of GDP.

Scholars cannot agree whether the technique worked. On the positive side, Japanese GDP didn’t
shrink. On the negative side, GDP growth was moderate and not sustained after quantitative
easing ended. Also, the experiment coincided with a big programme of government spending, so
no one can tell whether it was the unusual monetary policy or the intense fiscal policy that kept
the wolf from the door.
Almost no one would argue that Japanese quantitative easing was an unqualified success. But
some economists think the Japanese were too slow and too half-hearted in applying the therapy.
What’s more, the Japanese record isn’t necessarily all that meaningful for the US and the UK.
Quantitative easing may work better – or worse – in a country like Japan with a cultural
preference for savings and a huge trade surplus than in lands where borrow-and-spend have been
the rule for years.

Unintended side-effects

Even if quantitative easing isn’t necessarily effective, it would certainly be worth a try if it
carried no danger. But its safety is far from certain. It could theoretically lead to the
debauchment of a nation’s currency and inflation.

Again history doesn’t provide much of a guide. Japan hasn’t suffered any bad side-effects –
inflation is low and the yen is strong. However, in some more extreme examples of old-
fashioned money printing, the results were disastrous. Witness the assignats of the French
Revolution, Confederate dollars in the Civil War, Reichsmarks in Germany after World War I,
Russian roubles after the fall of communism and the current hyper-inflation in Zimbabwe.

The US and UK are, of course, in a far healthier state than revolutionary France or the Weimar
Republic. So there isn’t a danger of such alarming consequences. But central banks might lack
the will to engage in “quantitative tightening” when the economy starts to pick up.

In theory, reversing the policy should be quite easy. The central bank could just sell the excess
assets on its balance sheet, sucking money out of the system. In practice, the political pressure to
keep the party going might be too hard to resist.

This is particularly so because, in order to engage in quantitative easing in the first place, some
central banks may well need the permission of their governments. The more they work in
cahoots with politicians, the more their independence will come under threat. Already, Alastair
Darling, the UK Chancellor of the Exchequer, has made it clear that the government – not the
Bank of England – will play an active role if quantitative easing proves necessary.

It is therefore essential that both central banks and finance ministers commit themselves to
reverse quantitative easing when the good times return - before they go wild and open the
spigots. Quantitative easing is risky. It needs to be practised safely.
They’re right on at least one point. You should not bang your head against a wall, because
American health care is too expensive. Other than that, the charges made against America’s
Federal Reserve sounds to me like another anti-government clip. It is a pity that we cannot verify
the effects of quantitative easing (QE), of which we saw another round only several weeks ago
(known as QE2). What is not true about it is that all or even most economists agree that its
effects are futile. On the contrary, though I have never held a worldwide poll to see what most of
them do seem to think, I have always been under the impression that most regarded it to be a
sensible solution to the much more serious problem of deflation (applied to the American
scenario).

This small clip tries to leave us with the impression that it is a bad thing that the US dollar is
becoming less valuable. After all, you can buy less petrol, health care or any other good when
your money is decreasing in value. If the world were that simple, those cartoon figures would
have been dead right. But suppose for the sake of argument that things were the other way
around, i.e. that the dollar would increase in value. What would that mean for American citizens?
Isn’t their problem that they are already over-indebted? What would happen to mortgages and
loans? Do we honestly think that banks will suddenly proof to be our best friends by lowering
interest rates? Maybe, but I wouldn’t get my hopes up if I were you. It seems more likely to me
that, when money increases in value and the interest rates remain the same, that you’re going to
have to spend more of your money on things you don’t want to spend any more money on,
because somewhere in the line of production the value of the dollar will be charged. Albeit by
lowering loans or increasing retail prices; pay the consumer will.

And the problem the United States ought to avoid at almost all costs is the problem of deflation,
which would probably be the last phenomenon their economy could cope with (except maybe
new large ‘bubbles’). If QE is a fool-proof way to weaken a currency, something generally
assumed to be true, then that seems to be a sound decision to make. Printing money might sound
awful, but it’s an old name for a digital process. Moreover, if this process improves the
American export position by making American made products cheaper thanks to currency
exchange rates, then the world as a whole should probably give a welcoming applause.

Of course much depends on the rest of the world, too. China’s infuriating policy of pegging their
currency to the Dollar is one reason why the FED had to resort to another round of QE. It would
be too easy to just blame Ben Bernanke and his administration; all they try to do is to prevent a
further economical backdrop. China has given us some minor rays of hope that they’re going to
alter their policies, but the Yuan’s rise has been a meagre shadow in comparison to its expected
‘true’ market value. A rise of it would certainly help. At this moment we’re witnessing a blame
game between the two economic powers, both blaming the other for unfair measures that
endanger the others competitiveness. The truth is that as things are now, no one is really
profiting. China’s reserves are enormous, and its citizens have adopted this policy in the private
sphere as well. The American state and citizens are doing it just the other way around. If China
decides to de-peg its currency and let the market determine what it is worth, Chinese consumers
would most most likely see their capital’s worth increase, enabling them to go on a spending-
frenzy or – more reasonable for a country with prudent, saving citizens –a significant rise in
consumption.
This would partially hurt China’s industrial competitiveness, as payrolls will become a higher
burden to companies, yet China could acquire more wealth and prosperity, and it already proved
to be highly skilled in copying technological know-how, which should in any case become the
aim if it wants to secure a permanent place among this world’s economic giants. America in turn
would be better placed to export more to China, while importing less, and that is exactly what it
needs. Obama has stressed over and over again that the world must not expect to financially
thrive on American spending thrift, and quantitative easing just proves that he is serious. For
Europe and the U.K. another round of QE is not particularly pleasing news. The Euro and Pound
will become more expensive and that constitutes a potential threat to the U.K.’s, Germany’s and
the Netherland’s bounces in exports. Now if this would only have been in relation to the USA, it
would – for long term economical stability – be a good thing, but, because China is still
clenching on to the dollar, it’s a double loss. It’s not altogether surprising, therefore, that
America isn’t the only one calling for a rise in the Yuan’s value.

Europe’s “hopes” now lay in Ireland, Spain, Greece, Portugal and Italy, but as I wrote several
days earlier, that hope can lead to a decrease of market confidence in the euro (i.e. a less valuable
currency, which would help exports), or in a mind boggling blow possibly endangering the
survival of the Eurozone (which is obviously not a good thing). Within Europe we find a
reflection of the China vs. America battle. It is easy to simplify the Eurozone’s woes by pointing
an accusing finger towards any one of the mischief countries, but there are more differences than
fiscal austerity in the north, and spending madness in the south (pretending that Ireland is a
southern nation here). Revivals of countries such as Germany and the Netherlands are highly
leaning on exports, and this demands that there are other countries dependant on imports. One
thing Europe will have to work out in the future is how to balance the imbalances within its
single market.

This could, for instance, mean that some nations would have to politically refocus their
economy, making exports less prominent. I can’t see this happening – especially not in the
current climate. But to find a solution for this problem, the European Commission will have to
see other ways to boost the competitiveness of the regions that are less well off. People like to
echo the argument that, as the 16 Euro countries can no longer devaluate, it is hard to adapt to
economic fluctuations, but be honest: Do you think the USA is a homogenous country when it
comes to finances? Of course it isn’t, nor is China.

The European Central Bank has taken similar steps as the Federal Reserve by buying
government bonds. It has been criticized as a lost of political independence, though I still think
pragmatic solutions are better than politically independent economical stupidity. The moral of
this story – which admittedly went a bit astray – is that we should not blame the FED too easily.
The global market draws a lot of attention, and while not everyone is an economist, that does not
mean people cannot contribute to the debate. After all, as the above clip’s ironic remarks tell us,
it is our tax money that is being devalued whenever a government starts ‘printing money’. We
would do well, however, not to infect this debate by pretending the other side has nothing at all
to go on.
TORONTO (Dow Jones)--The world is witnessing a remarkably rapid shift in global power and
influence from the U.S. to China, billionaire financier and philanthropist George Soros said here
Monday.

Whereas the U.S. remains mired in the financial crisis that began in its own financial system,
China continues to function effectively and achieve a large trade surplus, Soros said in a speech
Monday.

"The crisis there was purely external and the system unscathed," he said.

Current systems of global governance are on the brink of breaking down as the G20 group of
advanced and emerging economies falls prey to internal tensions, he said.

China has become the "motor" of the global economy and political instability there would have
global consequences, he said.

Soros was speaking at a dinner in Toronto after receiving the "Globalist of the Year" award from
the Canadian International Council.

The fact that China's currency is essentially fixed to the U.S. dollar makes the resolution of
global trade imbalances difficult, Soros said.

But China's undervalued currency is also at the core of the effectiveness of its government
because it enables the government to essentially transfer wealth from those earning it to the
government in the form of its roughly $2.4 trillion in foreign exchange reserves, he said.

"It makes for a powerful government in China," he said.

The Chinese government has more policy options than the U.S. because it has a substantial trade
surplus, he said.

China must begin to assume more responsibility for helping shape global financial order, Soros
said.

"China has risen very rapidly by looking after its own interest," he said. "They've now got to
accept the responsibility for world order, and therefore the interests of other people, as well," he
said.

"If they persist in their present course, it will lead to conflict," he said.

Soros said the rejection of fiscal stimulus implicit in the recent midterm elections in the U.S.
made it necessary for the U.S. Federal Reserve to embark on quantitative easing, a form of
monetary stimulus where the central bank increases the money supply by purchasing government
bonds or other assets.
But quantitative easing is not the most desirable policy option as a replacement because it has
"harmful side effects," he said.

"History shows that it gives rise to asset bubbles and it disrupts foreign exchange markets, which
is in fact...what has happened," he said. "Quantitative easing is getting a lot of criticism both
internally and internationally."

The negative response to quantitative easing created tensions between the U.S. and China during
the recent G20 meeting in South Korea, although both sides were "right," he said. "There ought
to be some kind of balanced compromise between them," Soros said, adding that a such a
compromise would include some appreciation of the Chinese currency.

Soros said the euro is "clearly here to stay" as a result of the European Union's commitment to
monetary union expressed through its decision to launch a bailout package for Greece earlier this
year.

Sovereign debt concerns have become the dominant issue in financial markets in recent months
because of the problems in some of the peripheral economies in Europe, he said.
Xinhua Beijing on Nov. 5 (Xinhua Liu Ping) Federal Reserve policy of quantitative easing by the
new round of international concern. People's Bank of China Governor Zhou Xiaochuan said on
the 5th, a new round of quantitative easing policy in terms of the United States may be an
optimal choice, but its global role, it is not necessarily an optimal choice, may have other side
effects .

Zhou Xiaochuan said at a "new fiscal 2010 Summit: China and the world," said the Function
from the Fed, it is responsible for the U.S. economy, that create American jobs and keep the
United States responsible for low inflation. Therefore, if the U.S. economic recovery is weak and
unemployment high in the U.S. federal funds rate is close to zero under the circumstances, the
number of loose-type policies, there is the background.

He said the People's Bank of China in a variety of occasions and the Fed had to communicate,
which take into account the monetary policy of the United States made a considerable
elaboration.

Zhou Xiaochuan pointed out that a policy for the United States is an optimization choice, but its
global role, it is not necessarily the optimal choice, may have other side effects.

he said, the U.S. dollar as an international currency, not only has the reserve currency of the
characteristics of a considerable number of global commodity trade, capital flows, direct
investment in the use of U.S. dollars. When the U.S. dollar as the status of such an important
international currency, if it is the role of international actors and domestic conflict, the
international monetary system should reflect the existing problems.
Analysts in Beijing said that in the domestic excess liquidity, high inflation against the backdrop of
China's monetary policy in response to two stressors at the same time, also to some extent help curb
U.S. "quantitative easing" policy of the evolution of the negative effects development. Chinese Academy
of Social Sciences and other institutions of the experts expressed this view.

Since the outbreak of the international financial crisis, major economies in Europe and America are still
struggling with economic weakness, rising unemployment, public finance imbalances and other issues.
The Fed also announced the beginning of the second round of "quantitative easing" monetary policy,
leading to inflation and the world is facing increasing pressure of hot money flowing.

Analysts believe that China and other economies of excess liquidity is taking shape, such as the right to
take effective control of liquidity measures, inflation pressures will inevitably be further demonstrated.
China's National Bureau of Statistics data show that in October CPI rose 4.4%, 4% for the first time
during the year and 24-month record high.

China's central bank in the first quarter monetary policy report that "money and credit growth is
gradually return to normal direction," the second quarterly report, use the "money and credit growth
from a high of 2009, the gradual return to normal," monetary conditions further confirmed the return to
normal. In the third quarter report, the central bank with "guiding monetary conditions gradually return
to normal levels" that its regulatory intentions.

Early November 2008, in order to withstand the global financial crisis on the adverse impact of China,
the Chinese government announced a major fiscal and monetary policy adjustments, by prudent fiscal
policy and tight monetary policy to active fiscal policy and loose monetary policy.

Today, with the better stabilize the domestic economy, excess liquidity, increasing inflationary
pressures, the Chinese currency in the appropriate use of specific tools. Following the October 19 the
central bank announced nearly three years since the first rate hike in less than a month, and decided on
November 16 raised the deposit from financial institutions of RMB deposit reserve ratio by 0.5
percentage points, which is China This year the main commercial bank reserve ratio raised the fifth.

Zuo Xiaolei, chief economist at Galaxy Securities, said, policies need to be a cumulative effect of the
introduction of rhythm from the central bank policy, Bank policy operations and other aspects to
facilitate the comprehensive judgments, the central bank raise interest rates again during the year is
very likely.

Analysts pointed out that the quantitative easing policy of the United States led to further proliferation
of external liquidity situation, the implementation of China's monetary policy is conducive to
management of inflation expectations, to a certain extent, U.S. monetary policy to offset the negative
effects. Central Bank Governor Sheng Songcheng Shenyang Branch has written that America's current
economic problems are mainly weak growth, high unemployment, but the main problem is that China's
current inflation increased sharply, and economic restructuring.
As the main international reserve currency, the United States monetary policy is a policy of other
countries to further adjust the compression of space. China to raise interest rates and other monetary
means will further stimulate the entry of hot money arbitrage, if not further raise interest rates and can
not effectively alleviate the inflationary pressure, how to choose a test of the wisdom of the Chinese
currency.

"The current inflationary pressure is still the main cause of excess domestic liquidity." Economy of China
Academy of Social Sciences Zhang Xiaojing, director of macroeconomic analysis, interest rates will
indeed play a side effect of speeding up the inflow of hot money, but can take measures to prevent its
impact on the economy; if not to raise interest rates and other monetary means, the momentum will be
difficult to suppress inflation.

Analysts believe that in today's complex domestic and international political and economic background,
a single tool for fear of completely deal with the economic situation, should be supplemented by various
means to be flexible and effective control. The one hand, the central bank monetary policy more
forward-looking, flexible and timely switch, the other is monetary policy, fiscal policy, a combination of
force, and respond to risks.
Quantitative easing has not had the desired effect in advanced economies, but the side effects on
the Asian region and other emerging market economies are already apparent, Hong Kong Chief
Executive Donald Tsang on Friday said on Friday at the Asia Pacific Economic Co-operation
CEO Summit in Yokohama.

Hong Kong Chief Executive Donald Tsang speaks during the APEC CEO Summit in Singapore
November 13, 2009.

"Given their better growth prospects compared to the US and Europe, Asian economies are
attracting huge amounts of excess liquidity in pursuit of higher yields. These money flows are
creating upward pressure on exchange rates, consumer price inflation and asset prices in the
region."

Addressing the business sector of Member Economies at the Summit Tsang noted Hong Kong
has been riding on Asian growth and the rise of other emerging economies, yet it is far out of
danger, with asset prices increasingly getting out of line with fundamentals and the US' second
round of quantitative easing on Asian economies.

Tsang said he is concerned about the impact of the US' second round of quantitative easing on
Asian economies, adding the macro environment is exceptionally abnormal, where asset prices
are increasingly getting out of line with fundamentals.

 He said while the worst of the global financial crisis may be over, the next wave will hit at the
corporate level through massive volatilities in the currency and securities markets. "We are not
out of the woods yet. Far from it."

According to Tsang, the extremely low interest rate and strong capital inflows into emerging
markets have increased the risk of asset bubbles, which will impact financial stability, and
regional and global economic growth.
Mitigation measures

Tsang said Hong Kong's property market is a "particular concern", noting measures have been
taken in recent months to increase housing supply and enhance market transparency.

"But we will not stop here. We will not hesitate to introduce further anti-speculative measures
when there is a need to do so. And because of their market-sensitive and urgent nature, there will
be no prior notice."

Tsang said Hong Kong is building on its role as a primary fund-raising platform for Mainland
China companies to become a premier listing and fund-raising centre in Asia for international
and regional companies, and to widen the scope of renminbi business to absorb the increased
liquidity.

RMB business outlook exciting

Delivering a speech on "The role of Hong Kong in International Financial Co-operation &
China's Financial Development" at a Foreign Correspondents' Club of Japan luncheon, Tsang
said the renminbi is presenting exciting business opportunities in Hong Kong's financial markets.

As further financial reform on the Mainland will involve liberalisation of the capital account to
gradually achieve full convertibility of the renminbi and link the domestic capital markets with
the rest of the world, Hong Kong will once again play a pivotal role with its well-established
financial markets and unique status under the One Country, Two Systems formula, he said.
America

 Business
 Ben Bernanke

US could need third dose of quantitative

easing, says Ben Bernanke
• Federal Reserve chair says more QE is 'certainly possible'
• Bernanke uses TV interview to stress fragility of US recovery
• QE comments raise demand for US government debt


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 Graeme Wearden
 guardian.co.uk, Monday 6 December 2010 10.21 GMT
 Article history
 Ben Bernanke said it was
'certainly possible' the US Federal Reserve would embark on a further round of quantitative
easing. Photograph: Jason Reed/Reuters

America may need a third dose of quantitative easing (QE) to avoid its economy slumping back
into recession, Ben Bernanke predicted last night.

The chairman of the Federal Reserve defended his decision to launch a second $600bn (£382bn)
stimulus programme – dubbed QE2 – last month. Appearing on CBS News's 60 Minutes,
Bernanke said it was "certainly possible" that the Fed would open the QE floodgates again, if the
US recovery does not pick up pace.

"It depends on the efficacy of the [existing] programme. It depends on inflation. And finally it
depends on how the economy looks," Bernanke said.

Domestic critics have warned that QE2 will fuel inflation, while analysts and politicians overseas
are concerned that the plan is effectively devaluing the dollar and could disrupt the global
recovery.

Bernanke, though, insisted that buying up US government debt with freshly created money is
necessary to ward off deflation, and help to get more Americans back to work.

"Inflation is very, very low, which you think is a good thing and normally is a good thing. But
we're getting awfully close to the range where prices would actually start falling … That's
deflation and that's what happened in the Great Depression," he told CBS.

The US economy has been growing since the third quarter of 2009. Eight million jobs were lost
during the downturn, and only 1m have been created since the recovery started – leaving the
unemployment rate stubbornly close to 10%. Last Friday's disappointing non-farm payroll data
showed that just 39,000 new jobs were created in November – well below the 150,000 a month
needed to simply keep the unemployment rate stable.
Bernanke appeared keen to use his appearance on 60 Minutes to hammer home the message that
America's recovery is fragile. He indicated that a double-dip recession was unlikely, but partly
because some sectors such as housing are at such a low point that they cannot realistically drop
much further.

"It takes about 2.5% growth just to keep unemployment stable. And that's about what we're
getting. We're not very far from the level where the economy is not self-sustaining," he warned.
Bernanke also predicted that it could take "four or five years" to bring the US unemployment rate
down to 5%-6%.

The prospect of a third dose of QE raised demand for American government debt overnight, with
the price of US treasuries rising.

Gary Jenkins, head of fixed income research at Evolution Securities, said that Bernanke would
probably have spooked the markets if he had not suggested he was open to more quantitative
easing.

"His alternative is to say 'that's your lot, we are not buying anymore' in which case he would
probably create a major sell-off in the asset class," Jenkins said.
Europe
The U. S. Federal Reserve’s latest round of quantitative easing (QE2) may further escalate the
currency war by producing a crippling bout of deflation in Europe and conversely, another
period of inflation on the domestic front.

The diverse results are possible because further Fed purchases of debt are likely to re-ignite
economic growth and increase prices in the United States, while a surging Euro will make it
more difficult for European countries to pay off debt.

Fed purchases of Treasuries to stimulate the U.S. economy could send the euro rising against the
dollar, sparking deflation in Europe, Nobel Prize-winning economist Robert Mundell told
Bloomberg News.

The Fed announced yesterday (Wednesday) that it would buy an additional $600 billion of U.S.
Treasuries to spur the economy.

As the U.S further debases the dollar with another round of stimulus, the European Central Bank
(ECB) would be unlikely to stem the euro’s gains, Mundell told Bloomberg in an interview in
Beijing. In an earlier speech, he said U.S. quantitative easing would hurt nations around the
world.

The ECB’s mandate to control inflation would likely hamper it from stemming the euro’s rise,
while the currency’s gains would “likely lead to deflation,” Mundell said. Falling prices would
increase “the real value of indebtedness.”

Deflation would worsen European sovereign credit woes by making debts harder to pay off, said
Mundell, who won a Nobel Prize in economics in 1999 and is credited as the intellectual father
of the euro.

European governments imposed austerity measures after Greece nearly defaulted on its debt last
spring. The European Union was forced to assemble a $1 trillion rescue package, and members
Ireland, Portugal and Spain were clobbered by series of debt rating downgrades.

The ECB’s mandate to control inflation would likely hamper it from stemming the euro’s rise,
while the currency’s gains would “likely lead to deflation,” Mundell said. Falling prices would
increase “the real value of indebtedness.”

“Dollars were depreciating in value, dollars were the major reserve, this was a tax on dollars
held outside” the United States, Mundell said.

Mundell’s warning highlights how U.S. monetary policy may have potential unintended
consequences. Brazil said last month that the global economy is suffering from a “currency war”
as countries devalue their currencies in a “race to the bottom” in an effort to increase exports.
Others fear that by pumping more liquidity into the world’s largest economy, the Fed may be
risking a return to inflation for the second time in less than a decade by venturing down the same
policy path they followed in 2003-04

Earlier this decade the Fed kept borrowing costs at near record lows as inflation rose faster than
anticipated.

U.S. Federal Reserve Chairman Ben S. Bernanke risks increasing expectations for higher
inflation by too much, causing a shake- up in currency and bond markets, James D. Hamilton, a
University of California, San Diego economist told Bloomberg.

“That perception alone would bring about a series of immediate challenges, such as a rapid flight
from the dollar, commodity speculation and possible under-subscription to Treasury auctions,”
said Hamilton, a former visiting scholar at the Fed board and the New York and Atlanta district
banks. “So the Fed has a careful tightrope act here.”

The newest round of easing would probably cause inflation excluding food and energy to exceed
2% by 2012, above the Fed’s preferred gauge, according to seven economists surveyed by
Bloomberg.

“The parallels are very close to 2003, when the Fed had a maximum degree of panic about
deflation when inflation had already bottomed out and was about to pick up,” said Stephen
Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut.

“Their inflation forecasts are going to be too low, and as a result policy is going to be very easy,”
said Stanley, a former Richmond Fed researcher who expects 2.8% inflation in 2012.

As part of its announcement yesterday, the central bank released a statement in which
policymakers reiterated the view that “inflation is likely to remain subdued for some time.”

The Treasury market is pricing in lower inflation expectations than it should, said Michael Pond
of Barclays PLC told Bloomberg.

As a central bank governor in 2003, Bernanke pushed his peers to fight off deflation amid
sluggish job growth by keeping interest rates low. The central bank kept its target rate at 1% for
twelve months beginning in June 2003 to prevent prices from falling.

Meanwhile, inflation excluding food and energy rose from an initially reported 1.2% in May
2003 to above the Fed’s 2% goal a year later.

The Fed has kept interest rates between 0% and 0.25% since 2008 and purchased nearly $2
trillion in government bonds in an effort to increase GDP growth and stimulate hiring. 
Nevertheless, unemployment continues to hover near 10% and economic growth remains tepid
after the worst recession since the 1930s.
Despite the central bank’s unprecedented injections of liquidity, inflation has remained muted.
The Fed’s preferred price measure, which excludes food and fuel, rose 1.2% in September from a
year earlier, the smallest gain since September 2001.  The Fed’s long-term preferred range for
inflation is roughly 1.7% – 2%.

While a cheaper dollar tends to help U.S. exports, it also risks pushing up the price of oil and
other commodities, threatening an inflation surge that could be difficult to stop if the economy
picks up.

Indeed, oil prices have risen 18% since May, and food staples including corn and cattle are up
more than 20% this year, according to Bloomberg.
Japan
Quantitative easing in US and Japan
John Taylor has two nice graphs comparing the monetary base expansions in Japan and US as part of the
quantitative easing (QE) programs of the respective central banks, Bank of Japan and the Fed.

The BoJ's QE during the 2001-06 period increased the monetary base from about 65 trillion yen to 110
trillion yen, or by about 70%. The exit was swift and went without any volatility in the markets. Though
the post-2008 QE was small compared to the 2001-06 QE, the persisting deflation makes any exit from
monetary expansion difficult.

In contrast, the monetary base in the United States (to finance its purchase of mortgage backed
securities, bailouts of AIG and Bear Stearns and other loans and securities purchases) increased by twice
as much in percentage terms (140%) and much more quickly (especially in the last few months of 2008)
in the aftermath of the sub-prime mortgage bubble bursting. While the Fed entered into QE when the
interest rate target was 2%, the BOJ started QE when the interest rate was already essentially zero at
0.1%.

Prof. Taylor feels that the BoJ's quick and relatively problem-free exit from QE suggests that a quicker
exit for the Fed might notcause too many problems.

However, I feel that he may be asking the wrong question here. The debate now should not be about
the problems with managing an exit, but whether it is time yet (given the weak economy, business
investment and consumer demand, and continuing threat of deflation) to roll back the monetary
expansion.

The United States job report of December 3rd looks rather grim.  Unemployment rose to the 9.8
percent level after spending three months at 9.6 percent with the very, very modest addition of
39,000 nonfarm payroll jobs, likely just a statistical blip.  The total number of persons
unemployed rose to an astounding 15.1 million with 10 percent of adult men unemployed and
8.4 percent of women unemployed.  The jobless rate for Hispanics hit 13.2 percent and the
jobless rate for black workers hit a stratospheric 16 percent.  

The number of long-term unemployed (27 weeks and longer) was little changed at 6.3 million
and accounted for 41.9 percent of the total unemployed.  In addition, 9 million workers were
employed part-time for economic reasons (i.e. they'd prefer to work full-time but economic
conditions are not permitting them to find full-time work or their working hours had been
reduced).

The number of marginally attached workers reached 2.5 million, up from 2.3 million.  These are
workers that are not in the labour force, they want and are available for work and had looked for
work sometime in the past 12 months.  Statisticians for the Bureau of Labor Statistics (BLS) do
not count these workers among the unemployed because they had not looked for work during
the four weeks preceding the survey.  Among those, there were 1.3 million workers that are
classified as discouraged; these poor folks are not currently looking for work because they do
not believe that work is available.  This number is up markedly from 421,000 a year earlier. 

From the Shadow Government Statistics website, here is the chart showing the U3, U6 and
SGS unemployment statistics for the latest month:
Notice that the broadest measure of unemployment, the SGS Alternative which adds long-term
discouraged workers and BLS U-6 short-term discouraged workers to the U-3 BLS reported
unemployment statistic.  We can readily see that the SGS Alternative rate is still climbing and is
nearly 23 percent.  That's 1930's-style soup kitchen territory.

This week, we saw moderate mainstream media coverage of the funds loaned by the Federal
Reserve to Mr. Bernanke's cronies on Wall Street.  At least $3.3 trillion was loaned to banks
around the world in a last ditch attempt to keep the world economy afloat, to keep the stock
market from tanking and to preserve jobs.  As well, in November, Mr. Bernanke announced the
Fed's Quantitative Easing 2 program where the American central bank will purchase up to $600
billion worth of Treasuries through to June 2011 in yet another desperate attempt to keep
interest rates low, pour money into the economy and keep it humming on at least a few of its
eight cylinders.

The only country that has had an extensive experiment with quantitative easing is Japan as
noted in this posting.  Since 2001, the Bank of Japan has pushed its overnight rate down to
nearly zero percent where it has pretty much stayed.  Over a four year period, the BOJ also
increased the commercial bank current account balance from 5 trillion yen to 35 trillion yen and
tripled its purchase of long-term Japanese government bonds in an attempt to hold down long-
term interest rates and flatten the yield curve.  Again in October 2010, the BOJ announced an
easing of its interest rates from 0.1 percent to between zero and 0.1 percent and told the market
that it intended to increase its quantitative easing program by examining the purchase of $60
billion in additional assets.

Let's see how well the Japanese nearly decade-long experiment with QE has worked for the
Japanese worker by looking at the rise in unemployment since 1980:
Unemployment in Japan hovered around 2 percent in 1980 and didn't start to rise significantly
until early 1998 when it started to rise.  It peaked at 5.5 percent in early to mid- 2002, about a
year after the BOJ announced its QE program.

Now let's look at the trend in Japan's unemployment data since the BOJ announced its QE
program: 

As I noted before, Japan's unemployment rate peaked at 5.5 percent in early to mid- 2002, one
year after the QE program was announced.  Allowing for some lag time for QE to take effect, we
see that unemployment dropped rather rapidly to 3.6 percent in late 2007 but the rate didn't stay
that low for very long and was still above its historical range of 2 to 3 percent.  The rate rose
markedly as the Great Recession kicked in during the last half of 2008 and first half of 2009 to
reach a peak of 5.6 percent, worse than what was seen before the BOJ's QE program
implementation.  While these unemployment numbers appear low to those outside of Japan,
unemployment numbers of this magnitude are considered extremely high and unacceptable by
Japanese society.  In fact, having visited Japan last year, I was shocked at the number of
people squatting in tent villages under highway bypasses right in the middle of Shinjuku, one of
the business hubs of Tokyo.
These statistics tell us that, while quantitative easing may have had some impact on the
unemployment rate in Japan, the effects are not lasting and external economic pressures (i.e. a
major world recession) can undo all of the positive effects very rapidly and unemployment can
rise to very high pre-quantitative easing levels very rapidly.  It makes one wonder whether the
risks involved in flooding the economy with paper money are worth it.

I hope this is not a lesson lost on Mr. Bernanke and the Federal Reserve.

Here are the URLs for two additional postings I've done showing additional impacts of the Bank
of Japan's quantitative easing program.  The first posting shows the impact on Japan's overall
economy and the second shows the impact on the Japanese Nikkei 225:
t's been almost two years since the Federal Reserve set interest rates to the current near-zero
levels. The Fed has kept the target range for the federal funds rate (the interest rate at which
banks lend to each other) between zero and 0.25 percent since December 2008 and has, since
March 2009, repeated its pledge to keep rates low for an "extended period." That's a signal that it
doesn't plan on changing its tune any time soon, experts say.

On top of record-low interest rates, the Fed has also pursued a strategy called quantitative easing,
which involves buying up government securities like treasuries to push interest rates even lower
in hopes of stimulating more lending to spur economic activity. The first round of quantitative
easing started in 2008, and many experts believe the Fed will announce plans to begin another
asset-buying program (referred to as QE2) in its next rate announcement in November. Here are
four reasons why another round of asset purchases could be problematic:

[See top-rated funds by category ranked by U.S. News Score.]

Savers are hurting. The yield on the 10-year treasury note has hovered around 2.5 percent for
most of the latter half of 2010. Historically, rates have been much higher. In mid-2007, when
economic growth was much more robust and demand for treasuries was much lower, 10-year
treasuries were yielding as much as 5 percent. Many older investors depend on the income they
receive from their investments in high-quality bonds like treasuries, and faced with paltry
treasury yields, many are considering whether they should take on more risk. "It forces people
out the risk spectrum in order to get yield, and a lot of people that are forced out the risk
spectrum shouldn't be forced out the risk spectrum," says Liz Ann Sonders, chief investment
strategist at Charles Schwab. Rates can only move higher, and when they do, investors that have
moved farther down the duration scale (a measure of interest-rate sensitivity) will feel the pain.
When interest rates rise, the price of bonds falls—and longer duration bonds will be hit harder
than others.

[See 4 Reasons to Look Beyond Treasuries.]

It would add to the deficit. By buying up more assets, the Fed is essentially printing more
money and adding to the already ballooning deficit. If the Fed were to buy up more securities, it
must print the money to do so. It is expected to buy more treasuries if it pursues another easing
strategy. In this case, Sonders says the biggest holders of these treasuries are banks, so the Fed is
effectively putting the cash into the banks and taking the treasuries off the banks' books. The
hope is that this will stimulate big banks to lend more instead of sit on piles of cash. In a recent
note, Richard B. Hoey, chief economist at BNY Mellon writes, "We believe that QE2 would be a
powerful medicine with potentially severe side effects. While the Federal Reserve could force
down treasury bond yields temporarily by creating a temporary scarcity of long-duration treasury
securities, it would do so at the cost of higher treasury bond yields in future years, when rising
treasury debt will need to be permanently financed." In other words, buying more treasuries now
could lead to bigger issues down the road when the government is forced to take on the issue of
its massive deficit.
Activity is frozen. When the Fed says it doesn't plan on raising rates for an "extended period,"
it's essentially saying that there's a good chance the situation won't change much in the short
term. "It basically halts activity because if you anticipate rates are going down in the future,
there's no incentive to do anything now," Sonders says. "There's no fire that's lit under borrowers
or lenders." If the Fed were to change its tone somewhat, investors, businesses, and banks may
reconsider the way they view the situation. Sonders believes that if the Fed were to change its
views, it would inspire institutions to act instead of sitting back while interest rates remain near
zero for an indefinite amount of time.