The economy could not be collapsing at a worse time for President Barack Obama. With the vote coming in less than five months, stock markets are being whipsawed, unemployment is rising and the credit meltdown in Europe could wreak havoc on the world’s economies. But Obama has a powerful ally in the Federal Reserve. The central bank is set to launch a third round of quantitative easing (QE3) to keep interest rates artificially low and perhaps rescue his Presidency.
Fed fixing will certainly bleed the value of the greenback over the long term, but it just might give the economy enough lift to give Obama a second term.
Quantitative easing is when the Federal Reserve steps in to buy U.S. Treasury debt at weekly auctions during periods when individual investors and foreign nations are no longer keen to take on more of Uncle Sam’s IOUs.
Quantitative easing was rare before the economic crisis of 2008. That was when the Fed decided it had to pull out all stops to reflate an economy that really needed the excesses squeezed out of it.
When I started writing about such things in 1981, the primary buyers of U.S. Treasuries were American individuals and corporations. By the late 1990s, countries, particularly China and Japan, started buying Treasury bills, notes and bonds.
In more recent years, individuals, companies and foreign powers were no longer so willing to buy Treasuries. Still, the Federal government had to finance its spending sprees.
The Fed has been bankrolling Obama. Since his Presidency began in January 2009, the Federal Reserve’s holdings of U.S. government debt have quintupled. The Fed’s official numbers show that Treasury holdings have risen 452 percent in the past 3.5 years.
When Obama moved into the Oval Office the Fed owned just over $300 billion in U.S. Treasury securities. The latest data indicate the Fed owns 5.5 times more in U.S. Treasury securities, or $1.668 trillion. With Federal Reserve Chairman Ben Bernanke mulling over a third round of Treasury purchases, the central bank may own $2 trillion in Federal debt by election time. That would be one hell of a summer kicker for the economy going into the November election, and it would boost Obama’s chances of winning.
Obama’s Legacy And The Law of Diminishing Returns
Total U.S. government debt has grown from $10.6 trillion when Obama took office to $15.8 trillion this month. That is an increase of $5.2 trillion in 41 months. That is more debt than the U.S. accumulated between 1977 and 2002. The biggest buyer, the Fed, has to date rescued Obama from being a worse President than Herbert Hoover.
Yet the Fed must understand the law of diminishing returns. I learned it as an 18-year-old during in my first economics 201 lecture.
“Say you put in a tough day’s work,” said the professor. “You get home and there in the fridge is a case of Coke. The first bottle is amazing because you are so thirsty. The second bottle is good, but not as good. The third bottle…”
It is no different for the Federal Reserve and its systematic program of bailing out the President through quantitative easing.
But would QE3 really be enough of an economic game changer to alter the current political dynamic? According to The Wall Street Journal, it cannot resurrect the economy:
The bulk of the accumulating evidence suggests that the Fed’s initiatives made financial conditions easier than they would otherwise be. …
But easing financial conditions isn’t an end in itself. “It [QE] had an effect on the Treasury market, but did it translate into output and employment?” asks Philadelphia Fed President Charles Plosser, a QE doubter.
Even some QE defenders see a problem, which is one reason unemployment remains so high. “The channels through which monetary policy stimulates the economy are weaker than normal right now,” New York Fed President William Dudley has said. Mortgage rates are way down, for instance, but it’s so hard for would-be home buyers or refinancers to get loans that the economic oomph is diluted. Interest rates are lower, but small-business owners find borrowing against home equity or credit cards tough. Similar issues plague the Bank of England.
Larry Summers, a Democrat, agrees about the ineffectiveness of the Fed’s Obama bailout policies and their lasting impact on the economy. According to Summers, President Bill Clinton’s treasury secretary, another round of quantitative easing may drive interest rates down temporarily but will not encourage borrowing by corporations or even individuals. If companies and people don’t borrow, jobs will not be created.
Agora Financial LLC’s Whiskey and Gunpowder was more direct in its assessment last week: “QE, … by Bernanke’s own admission, is a giant placebo: It is not true medication as it evidently does not address the economy’s fundamental ills, but a tool for nationwide mass hypnosis. It is a kind-of anti-depressant, a kind of monetary Prozac.”
In the end it means the Federal Reserve is buying more of Uncle Sam’s debt, which may rescue only one job: Obama’s.
It is hard to know whether Bernanke and the regional presidents of the Fed will buy hundreds of billions of dollars’ worth of additional Treasury debt just to support Obama’s re-election or if they will do it out of fear that without this intervention America may fall off a cliff.
That conundrum brings me to my second memorable lesson in economics, one I learned from my late father. He said the power of the markets to deflate will always trump the power of governments and central banks to inflate. Given that tens of trillions of dollars were wiped out during the global stock market crash in 2008, I am convinced that he was correct.
The bottom line is that two things are happening simultaneously: The global depression that began four years ago is a sword still poised over all of our heads, and whatever fiddling the Fed does over the next few months will only delay the falling of that sword. In the end, all of the king’s horses and all of the king’s men will not put the dollar back together again.
Yours in good times and bad,
Editor, Myers’ Energy & Gold Report