Saturday, November 27, 2010


To the degree that taking out a second credit card when deeply in debt can be regarded as "prosperity," America's current economic state can be regarded as "recovery." 

At least Wall Street has been doing well with ongoing government interventions. Elsewhere economic activity would have to be viewed as tepid, but certainly things aren't crashing and burning. So recovery I guess it is. 

Driving this recovery, the Fed first dropped the prime lending rate to zero, for the first time in history, late in 2008, where they've been ever since and show no signs of turning around. Any recovery has to be viewed in the light that the Fed is handing dollars to banks and investment banks scott free. 

These lower borrowing costs trickle down to the rest of the nation as somewhat lower mortgage rates, lower bond rates in general, and, I've argued, higher stock prices

But when that's not good enough, when the Fed has to do more before deflationary forces assert themselves, there is quantitive easing. Here the central bank starts buying bonds—typically treasury but any kind will do—with freshly printed money. This accomplishes two things: (1) it drives bond rates down since bond sellers no longer have to offer interest rates which are as attractive, so borrowing costs overall are lower, and (2) it introduces a bolus infusion of cash into the economy, which is a temporary inflationary force to be reversed as the bonds mature and the minted cash returns to the bowells of the Fed.

The Fed began quantitative easing early in 2009, for around $2 trillion worth of treasury bonds and GSE debt, which recently came to completion. 

Surveying the economy, the Fed determined that more quantitive easing was necessary to stave away deflation. So, earlier this month a $600 treasury bond purchase was initiated by the Fed, known as "QE2." this wasn't unexpected to anyone following Fed activities, but did happen quietly and with little fanfare. Pretty much, it is a continuation of "QE1" rather than anything distinct. 

It does suggest that what economic forces and motives that dropped interest rates to 0% in the first place, and then initiated the first round of quantitive easing, are still with us today. 

Enjoy your recovery.

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