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American Capital Agency Corp. Message Board

  • Several news organizations and financial heavyweights have commented on the recent decision to extend QE. Most of the commentary has been negative,claiming Bernanke has lost credibility and that the markets seem more reliant than ever on QE. I agree.

    When I try to envision what the economy will look like in the future, I'm not coming up with a pretty picture. We know that each time QE has previously ended, the economy has not had sufficient strength to function without support, resulting in a drop in interest rates. (Interest rates are probably the best indicator of economic strength.) So I have to conclude that the future consists of one of three possibilities: 1) QE will continue forever. 2) Sufficient economic strength will eventually be achieved to do without QE. or 3) QE ends and the economy turns down.

    The Fed has poured a huge amount of excess reserves into the financial system, with little benefit. It admits to having consistently overestimated the benefits of its stimulative measures for several years. Since QE has had minimal impact, why would that suddenly change. The Fed contribution to financial markets has to influence the decisions of others, that's basic economics. In addition, the longer the Fed participation, the more the economy becomes accustomed to the Fed's contribution, making withdrawal of QE more difficult. So possibility #2 above probably doesn't really exist. The longer it takes to reach a strong economy, the more that strength becomes imaginary and simply a result of QE, so the less likely it is to have a sustainable the economy without QE.

    We are in a bit of a pickle.

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    • The Fed QE has been buying T bonds and mortgages with "free money". The Fed will eventually have to stop buying more. The Fed does not intend to sell these assets when they stop buying but instead will let them "run off" when these debt instruments expire. In the meantime the Fed will earn mucho interest without risk. That interest is returned to the government. This unintended benefit (or was it intended?) will help fund part our government for free. Seems like a "sweet" pickle to be in with free profit coming from the Fed. There will be no losses incurred on the Fed balance sheet as a result of QE.

      • 1 Reply to bubblerforever
      • I agree with you. There's nothing inherently destructive in expanding the Fed balance sheet with bonds, purchased with excess reserves on which is paid only 0.25%. If one imagines the Fed balance sheet at $10 trillion, it would be returning a great deal of money to the treasury each year, essentially converting mortgage interest payments to US government revenue. It's very similar to the AGNC business model.

        My concern is this. If the Fed should ever have to restrain the economy to limit inflation, short term rates would probably have to rise more dramatically than in the past, when the banks had no excess reserves on which to draw. That could easily result in a more violent contraction, and deeper recession as a result. The Fed is currently experimenting with creative ways to control interest rates using repurchase agreements, and my guess is that it realizes that a large amount of excess reserves changes the rules of the game.

        I also don't like the fact that QE treats the symptoms and not the disease.

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