Too Much Candy: A Plain-and-Simple Way to Understand Quantitative Easing, Part 3

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Ben Bernanke recently announced that the Federal Reserve would hold short-term interest rates near zero.

Listening to Ben Bernanke announcing the Fed’s decision to buy mortgage-backed bonds until hell freezes over, I’m reminded of a British cartoon character called Billy Bunter. Bunter was a portly schoolboy who made a point of gobbling up as many candies and bon bons as he could get his hands on.  He didn’t have a beard, like Ben Bernanke does, but he was constantly being abused and berated by his peers, just as the current Chairman of  the Fed is today.

The Fed’s plan to buy up vast quantities of bonds in order to juice the economy sounds a lot like a plan hatched by Bunter to save the British candy industry by trying to eat all of its products. On the face of it, the plan looks reasonable: if Bunter gobbles up all the candies and jujubes on the shelves of the local candy stores, the shopkeepers will have to buy more. That demand will drive manufacturers to make more sweets, which means hiring more people, buying more equipment, developing more real estate, acquiring more raw materials and so on. A beneficial cycle ensues, and the candy industry booms.

 

(MORE: Will Open-Ended Bond Buying Drive Down Unemployment?)

Unfortunately, so does Bunter’s waistline.  And losing all of the excess weight that he gains in his heroic endeavors on behalf of the sweet business becomes a serious challenge.

The same goes for the Fed. At some point in the future it will have to sell all the bonds that it bought. Not just the $40 billion in mortgage-backed securities that it will buy each month from Fannie Mae and Freddie Mac, but also the more than $2 trillion in Treasury bonds that it bought in QE1 and QE2. Selling those bonds will be a painful process for our economy –  every bit as painful as doing endless laps of the rugby pitch would be for Billy Bunter. The bond sales will drive up interest rates, and therefore the cost of borrowing for consumers and companies. It will also increase the debt of the federal government, which right now isn’t paying interest on all that Treasury debt bought by the Fed, because the Fed rebates interest payments back to the Treasury. The public won’t be so generous.

Right now the Fed is basking in the applause of the stock market, just as Bunter would be welcomed enthusiastically by the owners of the local sweet shops. But after the binge comes the diet. One reason the US economy is struggling is because consumers are working to shed the debt acquired before the financial crisis. When the Fed goes on its regime, that struggle could become a torment.

(MORE: The S&P Soars, The Economy Snores)

Paddy Hirsch is the Senior Producer of Personal Finance at the public radio program Marketplace. He’s also the author of Man vs Markets, Economics Explained, Plain and Simple, a tongue-in-cheek guide to the workings of Wall Street. 

17 comments
IQMinusOne
IQMinusOne

There is an analysis from a Chinese sites:

1. Stuff like MBS has already been treated as US bonds, even better than cash in large mergers. So this QE actually is meaningless financially.

2. Hot money from QE1 and 2 went to China and inflated housing there.

3. Inflation in the US is in oil and food because the Wall Street set the price to strike (literal translation, whatever that means) Europe and China and because these prices are global.

4. In conclusion, QE3 is just a publicity meant to warn Romney and Ryan who expressed opposition to QEs.

wurman
wurman

Excuse me . . . did I miss some memo in which the definition and the actual functions of a "bond" were suddenly changed? Hello. Anyone in that cave. A bond buyer does not have to sell a bond. The buyer can choose to be a holder. Then the bond holder can wait for the bond to mature and collect the basis plus interest. It seems that some experts have marvelled at Bernanke's trading short-term treasuries for long-term bonds in QE2. Then buying mortgage backed securities during the interim and, now, more of them for QE3, avoids flooding cash into the monetary system and allows the Fed to sit on the bonds, collect the payoffs, or sell if their value drifts up in a sustained growth economy. Have to keep an eye on those Princeton gurus who know how bonds work.

Kasbohmc2
Kasbohmc2

Thank you, Time.com, for posting this article.  The author, "hits the nail on the head" in explaining the downsides of QE3 (Quantitative Easing 3).

The notion that throwing more money for the 3RD TIME in 10+ years will stimulate the economy is nonsense.  When Obama did it in 2007-08, it had no appreciable effect.  What makes anyone think it will be more effective this time around, especially since we're already very deep in debt?

We need to remove regulations on Industry, and allow them easier ways to open businesses up.  That will start the hiring cycle, which will boost the business cycle by injecting more buyers back into the economy.

Washington D.C. and the EPA (among a cadre of others) are suffocating business growth, and it's time we loosened the coils of the Government Boa Constrictor.

Sardonic_Soul
Sardonic_Soul

Bernanke is a Princeton Professor.  Princeton is best suited to producing Socialist Czars to run huge, meticulous, nitpicking bureaucracies.   Bernanke is making the world safe for our new masters -- his students from Princeton.  (Aptly named school, don't you think?)

BankerGolfer
BankerGolfer

Dear 99%:

The government works for us, not you. That's why we're the 1% and you are not.

Now go out and get more of our Republican friends elected to Congress so that we can be protected and you not so much.

Sincerely,

The 1%

Guest
Guest

This is just another bailout. A permanent one actually.

It's like when you are in a hole, you keep digging because someone is paying you to do so.

failureofreality
failureofreality

The basis for economics is scarcity.  Scarcity requires choices.  Choice means that

getting one thing entails giving up something else.  This is the essence of economics.  If there were no scarcity, there would be no need for economics and its study of making choices.

Ben Bernanke and the Federal Reserve have not been engaging in economic decisions.  They have not made choices.  Creating money out of thin air is not making a choice.  It is not economic. The practices of the Fed have resulted in the destruction of our economy.

Hirsch's analogy of Bunter eating candy only applies if Bunter can eat without limit.  The Fed can essentially eat without limit.

The federal government has injected over $10 trillion over the past ten years through deficit spending.  The Federal Reserve has injected another $2-$3

trillion.  The government has been stimulating the economy for over ten years.  Stimulus has not worked.  Stimulus did not start in 2008.  It started in 2001.

The people responsible for our current economic problems remain in power.  They remain in power because the government keeps them in power.  The Fed has really only accomplished one thing:  It has kept in power the criminals who have destroyed our economy. We will not be able to recover until they are removed from power.

SAP Training
SAP Training

There are only 3 things that I understand about Quantitative Easing: 1) If the first 2 didn't work, why would this?; 2) The Fed would have to dump (alright, fine -- SELL) all the bonds it bought. With the ever increasing interest rates, good luck with that; and 3) QE is an alternative to a government's irresponsible handling of the economy that they (Gov't) can't seem to  get the financial market to buy their debts.  And if this is so, isn't QE just a band-aid for a bigger problem??  

IQMinusOne
IQMinusOne

That's exactly why the US was downgraded again. Since this QE is perpetual, expect the downgrading to occur on a regular basis as well.

Brouie
Brouie

@Kasbohmc2 Obama wasn't in office in 2007. The Fed is pumping money into the economy to devalue the currency, which leads to an increased money supply, lower cost of credit, and hence, more lending and borrowing, which should lead to more business activity.  The problem is big banks aren't converting the credit the Fed allocates to their reserve accounts at the Fed to loans, and money that flows into the economy.  They are sitting on it, which defeats the whole point of monetary policy, which is to control the money supply to affect interest rates and inflation.  The level of moronic commenting on this article is absurd.  

Guest
Guest

Just like corruption occurs when communists in China are trying to be capitalists,  Corruption is  rampant too when Americans are trying to be socialists. Democracy doesn't seem to matter when money is driving people crazy.

America still has an innovative edge though. But as the Facebook IPO shows, that edge may be in danger.

Guest
Guest

This QE is further bailout for Fanny and Freddy.

The best thing for the poor is to teach them how to fish, not to give them fish.

Sardonic_Soul
Sardonic_Soul

A client of mine -- Fish and Game -- got 35 brand new 85,000 4X4 all terrain GM trucks!  They only need 25 (they only have 25 agents) but it's good to have spares!   The government bought 70 plus percent of GM's output since no one wants the cars.  This is socialism.

MorganGuyton
MorganGuyton

 Actually, the basis for capitalist economics is scarcity. It's a game of

musical chairs. Eventually there will only be a 10% employment rate in

America and financial derivatives will be the only products made.

mr3
mr3

@Brouie  "The level of moronic commenting on this article is absurd."  Is it really?  Because I'm seeing more common sense than misunderstandings...except in what you're saying.  There's a reason that banks (still 8 months later) aren't converting stimulus into loans.  It's because few people are borrowing.  And there's a reason for that, and it's as much common sense: people don't tend to borrow in a depressed economic climate, and they won't change their minds sooner just because the Fed thinks they can change their mind.  Worse than that, it's actually the least likely time that people will actually borrow (or even lend beyond the most risk-free scenarios).  That's also the main reason we're not seeing inflation, and Bernanke knows (knew) it.  It's hard for inflation to occur without an actual substantive purchase level.


Want to know what's *really moronic*?  The notion that monetary policy, "jobs creation", "New Deal"s, and a host of other related concepts can have any positive impact on the core cause of stagnation in our system beyond delaying economic response.  You can make money as accessible as possible, but no one is ultimately going to care when no one is ultimately spending.  How hard is that concept to understand?  You can form public works jobs until the cows come home, but if the things people currently want to buy have nothing to do with the results of those public works jobs then there's not going to be any "priming of the pump".  "Oh but those people in those programs will have some money, and they'll buy things, which gives companies business, and they'll in turn spend, and so on".  Uh...no.  There's a basic reason why it has never and will never work in systems like ours.  Spending won't stimulate more spending unless that spending is sufficiently related to things people on a wider scale want to buy within a reasonable timeframe.  That's a fundamental aspect of our system or any other that provides choice in consumption.  Some of the most prominent economists believe ideas like this that fail to even acknowledge nth order effects of the most basic action/reaction form, and it still continues to shock me how little they understand economics.  12+ years of college and who-knows-how-many-years of research/discourse in a field, yet still people believe obviously broken ideas: now *that's* moronic.

Sardonic_Soul
Sardonic_Soul

Very good.  You can't really have a socialism with free enterprise, because that automatically generates a two tier economy.   Those who are making a killing supplying wants and needs, and those living a subsistence living under the socialism.    The transition -- as Obama is guiding us now -- is where the corruption comes in.  NOW is the time for Obama's people to grab the "wealth" that they "intend" to spread -- some day!  Soon!   And then squirrel it away behind a web of new laws and exceptions for themselves.  Obama's trying hard to curb and possibly kill the innovative edge by dumbing down the education system.  But it's a pendulum.  The backlash is going to be ferocious.

Pc Cobra
Pc Cobra

 You are correct.  The backlash will be ferocious.  When Romney takes office and gives all his billionaire friends tax breaks the regular folks will pay for, the two class system expands as it has been (long before Obama took office).  Too many Right siders and Left siders are blaming the "other" side for all the failures of the economy and America policy when it in fact is the problem of BOTH sides because they spend all their time trying to thwart the other side's progress instead of working together for our united betterment.  Also, I've noted in the chats around the water cooler that all the Obama bashing about the economy centers on what he has or has not done.  Yet NO ONE has a long enough memory to remember the economy went into the dumps when a Republican was in office and Obama may well have kept the Recession from becoming a Depression.  Going further back, BEFORE Bush, we had Clinton, who had the country on track for paying off the debt.  So lets look at the score card.  Bush 1 - runs up debt, gives millionaires like himself tax breaks.  Clinton - stabilizes economy and puts us on track to prosperity.  Bush 2 - runs up debt, gives millionaires like himself tax breaks and starts useless wars that bankrupt the country.  Obama - takes an impossible task of a spiraling country and tries to stabilize it.  So it appears the Republicans are constantly running the country into the ground and the Democrats keep saving it.  I understand the concept of giving the people who have money tax breaks.  You hope they will invest in the economy and create jobs which in turn increases revenue.  But the rich aren't creating jobs.  They are investing in the markets (driving up oil and gold, etc), making a killing, while the jobs remain non existent for the other tier of people.  Best bet is to let China cash in all our debt and just take over.  Then there will be no issues about who owns what islands.