The US political crisis that took place in July-August 2011 and nearly pushed the USA into the abyss of default didn’t make quantitative easing (QE1, QE2) more popular. Today more and more expert speak in favor of another round of quantitative easing – QE3. But is it really necessary for the US and the rest of the world? What will happen to the US Dollar if QE3 is implemented?
What Is QE And How Does It Influence The US Dollar?
Quantitative easing is an unconventional monetary policy used by a country’s central bank to stimulate the economy. It is done in the form of increasing the money supply through buying T-bonds. An increase in the money supply stimulates consumption and production, thus contributing to the recovery of the national economy. But such measures have negative consequences including inflation growth and the devaluation of the national currency. Therefore, QE3 may result in the US Dollar losing its value against other major currencies.
Some US congressmen are concerned about the weak pace of the Su economic growth. Some of them say the recent and current economic improvement may be temporary.
In the meantime, the Fed Reserve Chairman Ben Bernanke seems to be skeptical. According to him, every new FOMC meeting leaves fewer chances of implementing QE3. During the recent FOMC meeting, only 2 members voted for QE3.
QE1 and QE2: Results
According to Eugene Olkhovsky, ’s leading expert from Canada, the previous 2 QE programs should have resulted in higher production and consumption and economic recovery along with higher inflation and weaker US currency.
QE1. The first round ended in 2009. The Fed Reserve spent $1.7 trillion on mortgage and Treasury bond purchases. As a result, the US economy started recovering, US stocks and indexes rallied as the US Dollar lost a bit of its value against other major currencies. Mortgage rates were reduced to record-high lows in order to stabilize the US housing market, which had collapsed and initiated the global crisis.
QE2. The 2nd round took place in Nov 2010 – June 2011. Most experts had a mixed feeling about the result of QE2. The Fed Reserve got excessive money supply and higher inflation instead of accelerating the US economic growth. QE2 was estimated at $600B.
Consequently, QE1 and QE2 cost the Fed Res over $2.3 trillion, not to mention the weakening of the US Dollar.
Operation Twist. In order to overcome the consequences of the 2008 crisis, the FRS had to implement 2 rounds of QE. The next plan aimed at stimulating the US economy was called Operation Twist. The similar operation was implemented in the 1960s.
US Economy, QE3 And USD Exchange Rate
Despite all its problems, the US economy remains the world’s number one. In early 2012 the US GDP accounted for 20% of the global GDP, with 45% of the global demand. That is why we can say that it is the USA that represents a striking example of the continuous (over 40 years) development, which is close to the ideal financial system, even despite the fact that some major market participants anticipate the collapse of the US Dollar.
Is there any alternative to the US Dollar? Alas, there is no such currency because:
1. The eurozone (with its common currency) is in crisis. .
2. The US won’t ever let the Swiss Franc or the British Pound dominate the global financial system while the USA is the global superpower.
3. Exporting countries are not interested in strong national currency (yuan, yen, ruble). Moreover, the US and European authorities won’t seem to voluntarily let Moscow or Beijing turn into global financial centers.
US Trade Deficit:
Nevertheless, even the greatest can show weakness. The US is no exception. Despite the fact that Washington, the IMF and the World Bank keep being optimistic over the prospects of the US economy and national currency, the imbalance is growing. Figures speak for themselves. In particular, the US public debt has already exceeded 100% of the GDP. The trade balance deficit is currently equal to 3.5% of the GDP, not to mention excessive household consumption amid astronomic debts (125%) and low saving rates (4.5%), which creates a difficult economic situation in the country.
Federal Reserve: Asset Dynamics
Only thanks to massive emissions of money implemented by the Federal Reserve since 2008 (it exceeded $2.5 trillion or 17% of the US GDP) the central bank managed to prevent the US economy from falling into recession (together will a collapse of the financial system). Indeed, today we cannot deny the fact that the US economy is recovering. But is there any fundamental support for this recovery?
In 2011 the US economic growth accelerated from 0.4% in Q1 2011 up to 3.0% in Q4 2011. Moreover, there was an increase in car sales. The Chicago PMI grew up to 64 points while the ISM index reached 56.8 points.
US Public Debt:
As we can see, Washington keeps supporting the illusion of stability and signs of recovery, but in reality, this illusion is sponsored by the Fed Reserve’s substantial financial injections. Besides, the budget deficit has been around 10% of the national GDP over the last 4 years. The consumer demand keeps declining. Only higher public spending seems to slow down the decline.
Money Emission:
The budget spending supports the artificial demand for US T-bonds. Cheap borrowing costs allow borrowing at negative rates. First of all, FRS (which is controlled by major Wall Street banks) creates demand for T-bonds. During the period of 2008- Feb 2012 the Fed Res increased the emission form $850 billion up to $3 trillion.
New Housing Units:
Investors should pay special attention to the “low base”. In Q1 2010 there was a 3.9% increase while in Q4 2010 it reached only 2.3%.
Free Meal Tickets:
US Dollar Prospects
Ben Bernanke may well abstain for QE3 if the US economy shows sound growth and the rate of inflation remains below 2%. In order to introduce another round of quantitative easing, the Congressmen need to see major threats to the US economy. For now, they are positive about the economic prospects. However, the latest economic data suggest that the US economy may need further stimulation in the form of quantitative easing.
As for EURUSD, reports that the currency pair has started another (3rd) bullish wave along the major rally seen in January-February 2012. At this point, we can see the initial stage of the first sub-wave inside the current rally. So, it the short run, it is better to go bullish after deep retracements.
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