Quantitative easing, while needed, is putting our economy at risk

Quantitative easing, for those that are not in the know (if you’re one of them, which rock have you been stuck under?), is a program of massive asset purchases by the Federal Reserve. While needed to stimulate a flagging economy and while it is a popular decision, many analysts and economists are expecting it to increase the long-term risks of uncontrolled inflation and devalue the US dollar significantly. But say what you will, it is a necessary evil and there was no way the Federal Reserve was not going to do it. It is merely a question balancing out the long-term and short-term risks. Amongst the latter you can count deflation and a double-dip recession, and that was a far less palatable option to the risks posed by the long-term use of this policy. Since quantitative easing might ease short-term risks, it was always going to be implemented.

But even in the short term, there are risks to be faced up to thanks to this second round of quantitative easing. For one, it will almost surely boost asset prices and if stocks and equities start to surge. That is a good thing as battered households can start to build wealth and repair their ravaged balance sheets. The private sector could lead the charge of the light brigade and show the way for an economic recovery. But what if it means that oil prices rise? If that happens, there is no way that households will spend more on discretionary items, and you can put that down entirely to any rise in price of gasoline.

In a similar vein, a spike in consumer and industrial commodities will also have a debilitating ripple effect on the economy as a whole. Speaking in simple terms, this round of quantitative easing needs to encourage investments instead of just boosting asset prices. If that doesn’t happen, a distortion in the resource allocation is quite possible as opposed to the shot in the arm for the economy that is badly needed at this point in time. And if there is any distortion, the most obvious manifestation of this is US Treasuries since that is what the Fed is planning to buy for itself in the shopping spree to beat all shopping sprees.

Some believe that the Fed will be buying a lot of these treasuries from private investors who will then use this money to reinvest themselves in the private sector, but that seems a bit utopian as dreams go. If this does happen, it will be immensely beneficial for the economy, make no mistake about it. Corporations and banks alike are hoarding their cash in vehicles such as Treasuries instead of engaging it in more productive uses. Treasuries just aren’t giving any real returns right now, so there is a lot of idle cash lying around. But what if investors buy Treasuries only to sell it to the Fed for a profit? Money will then chase Treasuries instead of wealth-building initiatives. That would be disastrous as banks are hugely exposed to Treasuries, and a financial crash would bring us back full circle to square one, staring down the gun of a financial barrels.