On Main Street USA and the Federal Reserve’s QE3
By: Guest Authors
With Dr. Jeffrey Herbener
Editor’s Note: The “V&V Q&A” is an e-publication from The Center for Vision & Values at Grove City College. In this latest edition, we interview the chair of the department of economics at Grove City College and fellow for economic theory & policy with the Center—Dr. Jeffrey Herbener—on Federal Reserve Chairman Ben Bernanke’s recent announcement regarding another huge round of bond buying. The Fed has done it again. But what will a third round of “quantitative easing” or “QE3” mean to the average Joe and Jane on Main Street, USA?
V&V: Dr. Herbener, what does this latest announcement from the Fed mean for those of us average folks on Main Street, USA?
Dr. Jeffrey Herbener: I’m afraid it doesn’t mean anything good. This is just a repetition of QE1. You may recall that the Fed engaged in the same activity following the 2008 crash. They bought mortgage-backed securities, not exactly the highest quality bonds available, right off the books of the banks in order to create solvency in the banking system. It was just a bailout. The Fed now possesses $843 billion in mortgage-backed securities. What I think they’re doing now with QE3 is just another round of bailouts to the broader holders of mortgage-backed securities.
V&V: Who are these holders of mortgage-backed securities?
Herbener: The biggest holders are Fannie Mae and Freddie Mac. Fannie has more than $2 trillion and Freddie has more than $1 trillion. The total mortgage-backed market is something in the neighborhood of $5 trillion. Even if the Fed chooses to buy in the open market—rather than buying from Fannie and Freddie directly—Fannie and Freddie will still benefit by the prices of their portfolios being driven up artificially by the Fed purchases.
V&V: So, you don’t agree with what we’re being told—that the purpose of this Fed action is to boost employment and the housing and stock markets?
Herbener: Right, I think that QE3 is a bailout of mortgage-backed securities holders. It makes little sense to think this action is designed to boost employment and the housing markets. The natural forces of the market are already correcting the difficulties in the housing market—housing prices are coming down and interest rates are at historic lows. And we certainly don’t need more housing or housing jobs because we have a glut in housing supply.
V&V: But what about the stock market? It surged the day after Mr. Bernanke’s announcement and the retirement accounts of everyone on Main Street got a boost.
Herbener: Well, what’s actually happening is that the Fed is simply creating volatility in the stock market by creating money out of thin air to buy bonds. The market surges because Wall Street knows the Fed’s new money will eventually work its way into the economy and into stocks. So, the stock market will experience an artificial boost, too. But, because it’s not a real, earnings-driven boost, the market will experience wild ups and downs. The average person on Main Street doesn’t really benefit from this type of artificial volatility.
V&V: Let’s talk about the expansion of the money supply, the real reason the folks on Wall Street are so excited about QE3. Can you tell us about that?
Herbener: Sure, it’s not as complex as you may think. Eventually, this money will end up in banks and banks can loan up to 20 times the amount of money they actually keep in the bank in the form of reserves. Prior to the 2008 crash, the American banking system had about $2 billion in reserves. Today, due to Fed action, banks possess a whopping $1.5 trillion in reserves. Multiply that by 20 and you have a mind-boggling potential to expand the money supply. And when the money supply inflates, prices for goods on Main Street inflate.
V&V: Do you think the money supply will inflate to $30 trillion?
Herbener: No, I think the Fed will intervene and attempt to remove money from the system. More likely, I think we’ll see double-digit inflation and a terribly dreary economy that looks like the 1970s. Back then we experienced both economic stagnation and inflation. Importantly, the Fed’s intervention will wreck the ability of entrepreneurs to make business decisions. It will cause further uncertainty. And uncertainty slows business and hampers a recovery in employment.
V&V: So, in summary, you’re saying that the Fed’s QE3 will actually have just the opposite of the intended effect? It will further exacerbate the unemployment problem? And it won’t help the housing markets and it will create volatility in the stock market? In other words, we can say for certain that the Fed’s action will lead to further economic uncertainty?
Herbener: That’s correct and it doesn’t bode well for Joe and Jane on Main Street, USA.
— Dr. Jeffrey Herbener is chair of the department of economics at Grove City College and fellow for economic theory & policy with The Center for Vision & Values.