Japan Redux - Scary Picture

Nope. Ask Riversider.

So, like Keynes, the fools that think that a lower rate of interest is always better urge that the Federal Reserve should expand its balance sheet and buy up more Treasuries, Agencies and Agency MBS, forcing rates lower. What good can come from forcing high-quality long rates lower?

My answer is, not much. Existing debts if non-callable, will be worth more. If debtors are solvent, and can refinance, they can lower their debt service costs, though that is a minority of borrowers. Beyond that, it will lead the favored debtors to borrow more %u2014 Treasury, Fannie, Freddie, etc. We need more borrowing, right?

But a greater effect can be the speculative frenzy engendered by dropping the rate that savers earn to such a low level, leading them to invest more aggressively to meet their income targets. As with any other sort of speculation, the game is over when people rely on the occurence of capital gains.

I think quantitative easing is a mistake; I also think it does not help matters much. It transfers resources from creditors to debtors in a funky way. That is not the right way to go if you want a country to grow. (Which, contrary to the received wisdom, would mean that raising short term rates would be better for the US and Japanese economies than engaging in quantitative easing. There would be short-term pain, but there will be pain regardless of how this policy is conducted.)

If the Fed makes a bow in the direction of quantitative easing on Tuesday, such as reinvesting the proceeds of MBS in more MBS, the markets will rally, but I would fade it, because it will have no long-term beneficial impact on the economy.

There is no free lunch. Any action that seems to cost nothing on the part of the Fed or the Federal Government will have no long-term effect on the economy. Quantitative easing is one of those comforting fairy tales that is a fraud, whether intentionally so, or not.

http://alephblog.com/2010/08/10/queasing-over-quantitative-easing/

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