High U.S. unemployment and slowing economic growth have stoked hopes of a third round of quantitative easing, or QE3, from the U.S. Federal Reserve. Fed Chairman Ben Bernanke hinted that more was on the way – although failed to indicate when – in a speech Friday at the Jackson Hole, WY, economic symposium.
Bernanke repeated the Fed's recent stance that current economic conditions are still "obviously far from satisfactory" and more help would be coming "as needed."
Interest rates remain near zero, but the Fed maintains that it still has plenty of ammo in its arsenal to boost the economy. The Fed apparently doesn't want to do too little now while the economy faces high unemployment and some inflationary pressure.
On the other hand, doing too much could – if Fed policies interfere with Congress' ability to act down the road -lead to a backlash against the Fed's power.
And the farther the Fed goes with monetary stimulus measures, the deeper that problem becomes.
That's why Harvard economist Martin Feldstein is afraid of QE3. He thinks adding to the billions of dollars already committed to quantitative easing programs will hurt us more than it helps.
Why Fear QE3
Feldstein, who also serves as an advisor to GOP presidential hopeful Mitt Romney, spoke to CNN Money about the dangers of QE3 just after Bernanke stated his case for more stimulus at Jackson Hole.
"The more liquidity you put out there, the greater that problem is going to be," said Feldstein. "When I talk to people at the Fed about this, they say – "we will do the right thing.' The only question is, what is the right thing? Is it the right thing not to risk losing authority, or is it the right thing to raise interest rates even if it involves that?"
Feldstein, who also served as chairman of the Council of Economics Advisers under President Ronald Reagan, outlined two of the major risks of QE3.
QE3 Risk #1: What's the Exit Strategy?
Feldstein said the risk worrying him most is how the Fed will tighten after years of looser monetary policy.
"We don't have a clear idea of how far they would have to raise rates to deal with banks that have more than a trillion dollars of excess reserves deposited at the Fed," Feldstein told CNN. "When the time comes they may have to raise rates a lot, and at the time, unemployment may be higher that it normally is when the Fed normally wants to raise rates-that's because of this big amount of long-term unemployment."
July's U.S. jobs report showed unemployment ticked up to 8.3%. August's numbers will come out this Friday, and analysts expect about 125,000 jobs to be added.
Feldstein explained that as the economy eventually recovers, with unemployment still stuck at a troublesome level, the Fed may feel the need to tighten but may be held back by a Congress that might retaliate.
"The Fed may feel they ought to tighten, but feel threatened that if they do, Congress may take away some of their powers," said Feldstein. "What does the Fed do if it thinks it could lose the right to buy anything other than Treasury bonds or the right to buy the quantity of bonds it's been buying?"
QE3 Risk #2: Fueling a Bond Bubble
CNN asked Feldstein if the central bank's actions are creating a bond bubble, and if so who would get hurt if it burst?
Feldstein said there is "absolutely" a potential bond bubble that could result in absolutely no buyers for U.S. Treasuries.
"If the Fed weren't buying and if the Chinese achieved their trade goal, ceasing to have a current account surplus (as they have said in their five-year plan)… they will not have the ability to buy our bonds. In fact they would have to sell bonds if they want to go around buying other things," said Feldstein.
He said the same could happen with the Japanese economy. If it improves, Japan could lose interest in U.S. Treasury bonds.
"Put all that together, and you could see interest rates returning to more normal levels," said Feldstein. "This spills over into equity markets, and if long-term bonds go up, mortgages go up, and the housing market gets hurt, we would all be the victims."
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Martin Feldstein: What worries me about QE3 - The New York Times:
Mr. Bernanke's Next Task
Please explain how a bond bubble with QE3 in 2013 would compare to the interest rate situation during the Carter Administration in 1979-1980 where mortgage interest rates went to 19%?
Surely you jest?
1) In 1979, the FED instituted a policy of monetarism and let the markets dictate the level of short-term rates.
2) In 1978, the FED eliminated REG Q and allowed banks/thrifts to charge market rates for savings and money market accounts
3) There was no swap markets to hedge interest rate risks and there was only an embryonic futures market. Even then, the rate on government guaranteed mortgages did not exceed 15%.
Let me guess, you think Ronald Reagan's "deficits don't matter" led to a massive decline in interest rates. And you voted twice for GW Bush and believe that he was a 'free marketer" who bravely served his country in Texas while cowards like Max Cleland and John Kerry hid out in Vietnam?