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Home > Blogs > Ian Fraser > "This is the monetary equivalent of a nuclear war"

"This is the monetary equivalent of a nuclear war"

QE2 | Ian Fraser

The Federal Reserve’s policy of effectively shafting its international creditors by debasing the dollar through the mechanism of quantitative easing ain’t nothing if it ain’t controversial.

On Wednesday November 3, the Fed announced it was embarking on a $600bn round of quantitative easing, which will see it buy $75 billion of long-term Treasury securities each month until the end of June 2011. Although it has buoyed up stock markets, commodity markets, etc, some economic commentators are deeply concerned about the possible casualties of this monetary equivalent of a nuclear strike.

In a column earlier this week, the Economist's Philip Coggan put his finger one of the biggest dangers of Fed chairman Ben Bernanke's policy - that it will heighten international tensions and exacerbarte the so-called "currency wars".

"The gut feeling that I have been expressing for a while is that the currency set-up is unsustainable and QE only adds to that sentiment. Can the world’s largest economy and debtor nation follow a consistent policy of devaluation, and thus penalising its creditors?"

On Monday Richard Fisher, president of the Dallas Fed and a member of the Federal Open Markets Committee added his voice to critics of the Fed's policy.

In a speech to the Association for Financial Professionals in San Antonio, Texas, Fisher said he feared that QE2 would give rise to "super-ordinary inflation", fuel financial speculation, create asset price bubbles, encourage the hoarding of commodities, while all the while failing to address America's number one economic weakness, its inability to create new jobs.

Fisher said the policy could only stack up if Washington was prepared to put its financial house in order and turn away from “fiscal incontinence and regulatory misfeasance.” Some hope!

Fisher said the danger of the Fed’s decision to launch a further $600bn round of QE was that such monetary largesse would come to be seen as the "new normal" of monetary policy, persuading investors to assume they could bank on a steady supply of "free" money to prop up markets.

“For the next eight months, the nation’s central bank will be monetizing the federal debt. This is risky business. We know that history is littered with the economic carcasses of nations that incorporated this as a regular central bank practice. So how can the decision made last Wednesday be justified?”

Given that US business and banks are currently hoarding cash on their balance sheets, Fisher said he coudn't understand why the Fed believes that it's lack of cash that is holding back the US economy. He said uncertainties over the future direction of fiscal and regulatory policy in the US were much more likely to lie behind corporate America's reluctance to hire people.

Fisher also warned that the Fed's ultra-loose monetary policy, including QE, is having some serious social consequences, including

"transferring income from the poor and the worker and the saver to the rich. Senior citizens and others who saved and played by the rules are earning nothing on their savings, while big debtors and too-big-to-fail oligopoly banks benefit from their subsidy."

Fed Governor Kevin Warsh is another QE2 sceptic. In a carefully-argued speech to the Securities Industry & Financial Markets Association on November 8, Warsh warned of the downsides of the policy.

"The Federal Reserve is not a repair shop for broken fiscal, trade, or regulatory policies. Given what ails us, additional monetary policy measures are, at best, poor substitutes for more powerful pro-growth policies...

"The Fed's increased presence in the market for long-term Treasury securities also poses non-trivial risks. [including distorting the price of the asset class, one of the bedrocks of the global financial system]... The shock that hit the financial markets in 2008 upon the imminent failures of Fannie Mae and Freddie Mac gives some indication of the harm that can be done when assets perceived to be relatively riskless turn out not to be.

... Heightened tensions in currency and capital markets could result in a more protracted and difficult global recovery. These, too, are developments that the FOMC must monitor carefully."

The last word, however, must go to Peter Schiff, president of Euro Pacific Capital, who has become positively apocalytic about the likely fallout of QE2. In a recent blog post Schiff wrote:

"As the world awaits another $500 billion flood from Bernanke's printing press, central bank governors from Brasília to Tokyo are preparing to respond in kind. This is the monetary equivalent of a nuclear war, except instead of radiation, bombs of inflation threaten to make the world economy uninhabitable for saving and productive enterprise...

"The end result is that the entire civilized world is locked in a race to inflate, and no fiat currency is truly safe."

Further reading on QE2 and its likely fallout:

Tags: asset price bubbles , currency wars , economic recovery , international differences , QE2 , quantitative easing
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