When All You Have is a Hammer…

There will be no need for the Federal Reserve to engage in Quantitative Easing 4. The Federal Reserve announced today that it will embark upon QE3 through through indefinite $40 billion monthly purchases of mortgage debt as an attempt to drive down unemployment and boost economic growth. In addition the Fed pledged to “purchase agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools” if the economy does not “improve substantially”. And if this wasn’t comforting enough, the FOMC also declared that the overnight Federal Funds rate will remain at zero “at least through mid-2015”.

This marks the 4th major Fed action taken since the financial crisis of 2008, each yielding subsequently smaller nominal gains in the market. While stock prices soared on the news (the DOJ up 1.55%), precious metals marked an even greater gain (Gold +1.97%, Silver +4.18%), signaling an understanding that this move will ultimately be bearish for the U.S. economy.

The problem with the Fed’s new policy announcement is the same problem that plagued each of its failed previous attempts to right the U.S. economy: Fed stimulus and ultra-low interest rates are the driving force behind malinvestment and entrepreneurial miscalculation, and a continuation of such a policy is not going to fix anything.

The failure of QE1, QE2, and Operation Twist to enact any sort of long term stability to the market shows the shortcomings of Fed monetary policy as a tool for economic recovery. Ultimately the only tool that the Fed has at its disposal is to print money (ie. create inflation) and use it to buy assets that are deemed too risky for the market. As the saying goes, if all have is a hammer, every problem looks like a nail…and the Federal Reserve has been hammering away with the same misguided policies for years.

The result of this indefinite money printing scheme will certainly be rising prices. To the extent that banks take this new money and loan it to customers, enormous amounts of money will enter the system and bid prices up. Perhaps even more damaging will be the continual propping up of mis-allocated resources and the prevention of a true correction from occurring. So long as interventionist monetary policy is the followed, the economy can never reach a truly healthy level.
While QE3 will certainly provide a short-term rise in asset prices, such gains will ultimately be unsustainable. Much like a crack addict will feel rejuvenized after taking another hit his drug problem is not cured in doing so, and the crash after is inevitable. What he really needs is rehab, regardless of the pain and discomfort it may cause him.

What we need is a dose of reality. To accept that to overcome our addiction to easy money and low interest rates we must experience a true economic recession that will actually liquidate the bad investments and allow us to emerge on a sound financial footing where the foundations of the economy are truly strong and not propped up by government stimulus.

Medicine may taste bad, but it is necessary to get well. Rehab may be painful, but it is the only way to get clean. Tightening monetary policy may cause a retraction, but it is the only way to truly cure this economic mess.

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4 thoughts on “When All You Have is a Hammer…

  1. The paranoid side of me says that if the government is holding all the mortgages and the economy collapses, the government will be the rightful owners of all the homes. Thus a backdoor form of communism.

    My jaw is still on the floor from what the Government and the Fed pulled off today. I think we’re way beyond the point of rehab.

    I wrote a similar blog post to yours.
    HK

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