As women, we’re often viewed as being afraid of, or not interested in, understanding the economy  and the intricacies of the government’s management of it. At Women’s Voices for Change, we’re fortunate to have several board members who are the essence of courage and intellectual capability in this field. This season, we’ve called on them to explore with us various aspects of the current economic climate, and what significance they might have for women over 40. First up: Kathleen Rogers, who explains the concept of “quantitative easing” and its role in shaping current economic policy. –Ed.

We need to understand quantitative easing because it will drive the stock market, bond prices and the value of the dollar.

Retirees are struggling right now because investment returns are so low that their pensions and IRAs are not producing enough interest income to meet their expenses.  Stock prices are where they were 10 years ago, and corporate bond rates average 3-4% (with U.S. Treasury rates even lower).  Quantitative Easing may make this worse.

The head of the U.S. Federal Reserve, Ben Bernanke, recently announced that unemployment is too high and inflation is too low, and something needs to be done.  Inflation too low?  Isn’t any inflation bad?  Well, in this sluggish economy, the Fed apparently thinks we now risk falling into a deflationary cycle (where prices of everything fall, creating a vicious cycle of fear-induced wallet-clutching, choking off economic growth).  The Fed estimates that prices are increasing only 0.8% annually right now.  But many market participants believe inflation is really closer to 2%, which is high enough so that we need not be concerned with deflation (the discrepancy arises from the different measurements of inflation compiled, as well as whether to include any aspect of volatile food and energy prices).  The other goal of the Fed is to increase employment.  Unemployment has been running between 9.5 and 10%, which is simply too high.

The standard way the Fed increases employment and stimulates the economy is to lower the Federal Funds Rate, the interest rate the Fed charges banks, which many other rates depend on.  However, this rate has been at virtual 0% for more than a year, and it hasn’t created sustained economic growth, partially because of all the financial losses homeowners are still holding on their mortgages.

As a result, in order to try to further lower interest rates, the Fed has resorted to buying up much of the U.S. Treasury debt, which has been named “Quantitative Easing.”  Quantitative Easing just means that the Fed buys (a LOT of) these bonds from major U.S. banks.  They pay for them just by increasing the number representing the balance of each bank’s account at the Fed.  That’s right, there is no actual money exchanged; the Fed is essentially printing money by simply adding digits to the Banks’ financial accounts when it takes these bonds.

If you took any economics courses, you know that when governments “print money,” it’s a little scary.  It can lead directly to inflation, often out-of-control inflation, because the intrinsic value of currency is eroded.  The Fed seems to think it’s a risk worth taking now because the economy has remained weak (they also seem to believe that they will be able to react quickly enough if inflation increases).  Others are less sanguine.  Many market participants fear that once inflation takes hold, it will be too late to stop it.

The Fed is expected to buy back about $50-100 billion worth of U.S. bonds per month until the economy strengthens.  The U.S. Treasury only issues about $100 billion net per month; they may buy back almost the equivalent of what’s being issued, which means they’ll be aggressively competing against the deep-pocketed foreign buyers of our debt, which will further drive down rates.

A hidden bonus, to the U.S., in buying back so much Treasury debt is that lower rates decrease the value of the dollar against other currencies, all other factors being equal.  When the dollar declines in value, it makes our goods and services cheaper in overseas markets, driving up demand here, creating more jobs.  However, it doesn’t look so good for the U.S. to overtly try to lower the value of the dollar because it’s the “reserve currency of the world”–most financial transactions still take place in dollars, not yen or euros.  It’s a bit unseemly for the U.S. to publicly debase the world’s legal tender.  Also, it would be announcing to the Chinese and other large holders of U.S. Debt that the value of their holdings is about to decline precipitously, which might make them less inclined to continue to buy our bonds.

Instead, the Treasury says it wants “a stable dollar,” but tacitly approves the Fed’s Quantitative Easing, depressing the dollar, which may be an unstated goal.

The Fed’s money-printing and mixed message on the currency constitute a bit of a wink-and-a-nod experiment with unknown consequences for the U.S. economy and the world.

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  • Marcy Recktenwald October 25, 2010 at 9:15 am

    Very clear and well written. How do you spell Keynes “Liquidity Trap?”