QE2 - The Last Resort

by Bill Sharon The Federal Reserve’s second round of Quantitative Easing or QE2 is set to launch next week.  Ask yourself and a half a dozen of your friends if you really know what that means.  Most of us don’t. Quantitative Easing was invented by the Bank of Japan during the 1990’s.  The idea is that the central bank creates money and buys bond assets from banks and other financial institutions.  That puts more money in the hands of the banks which they can then use to create even more money.  Theoretically, this money will then be lent to businesses that will use it to invest in their physical plants and hire people and get the economy moving.  It is often described as a last resort.  The reason it is called QE2 is because we have already tried it once before. The danger is that too much money will be flooded into the economy and high inflation or even hyperinflation could occur.  So far, that hasn’t happened.  Banks are not lending – not really.  They aren’t lending for two reasons.  From a regulatory perspective they know that they will attract tremendous scrutiny if they make questionable or high risk loans.  More importantly they understand what all of us understand – there is something fundamental going on in the economy that is hard to fully comprehend.  But there are some hints. The recent revelations that there were “robo-signers” in the processing of mortgages made headlines for a few days.  The documents underlying the foreclosure processes of many of the big banks were fraudulent.  That resulted in a pause in the foreclosure process but Bank of America has announced that it will resume foreclosures despite the mobilizing of state Attorneys General to oppose them.  That’s because the exposure from the lawsuits filed by the states and the homeowners are a minor problem compared to the lawsuits that are looming from the institutional investors.  Those investors - pension funds, mutual funds, etc. will expose organized fraud in the system.  It is one thing to say you were sloppy about the paperwork when processing a foreclosure.  It is quite another indeed to admit that you systematically lied about the products you were selling. Both events, QE2 and the impending collapse in confidence in the mortgage backed securities market demonstrate to the world that our money is worth far less than we believe that it is worth.  For the past forty years we have had a fiat currency.  That’s a currency that is not backed by a precious metal such as gold.  A dollar has been worth a dollar because we said so – and we had the economy and the military power to back it up.  That covered a multitude of sins.  It’s always dangerous when you believe your own press releases. The countries that hold our debt, most notably China, have reason to be upset.  Should their investments turn out to be worth considerably less than advertised (and they certainly are) the impact will be severe, not just within their borders, but around the world.  The dollar, despite half- hearted attempts to create an alternative, is still the reserve currency. For the first ten years of my adult life I had the opportunity to work in a series of psychiatric facilities.  During that time I discovered that the boundary between what was considered sane and insane moved on a regular basis, sometimes quite dramatically.  Certainly we look back on the burning of witches or the enslavement of other humans as bizarre behavior even though entire civilizations accepted them as normal.  We only need look back ten years to find a delusional system called the “new economy” in which websites with no discernable product, service or even functionality were worth millions.  We pass through these experiences and we are reluctant to call them “crazy”.  It must be something else. Our monetary system is a belief system.  A dollar has value because we (that’s the big “we” as in virtually all of us on the globe) believe that it does.  That belief is in a very precarious position.  We keep getting more and more information that questions its veracity.  The result of abandoning our belief in our currency is beyond comprehension.  Perhaps that is why, so far, we haven’t. But beliefs can change very quickly.  We discover that the lover we trusted has betrayed us and everything comes into question.  What we thought was real turns out to be false and we redefine our experience.  Sometimes this takes a long time, sometimes it happens very quickly.  It is hard to know if the dollar is in for a log decline or an abrupt fall.  What is clear is that we have emptied the toolbox.  We are out of strategies to fix it.