Levy, Harkins Q3 Letter
In the
middle of last month in response to desultory growth, Federal Reserve Chairman
Benjamin Bernanke announced Quantitative Easing III, a program most notable for
its claims to “unlimited” size. By the
calculation of Martin Feldstein in the Financial Times last week, “unlimited”
might come to $1.5 trillion of new money created in three years. To put such a sum in perspective, the Fed’s
assets totaled all of $825 billion at the beginning of the financial crisis in
late 2007. America’s leading economic light,
Professor Paul Krugman of Princeton, says that not only is there nothing
alarming about this, but that those of us who express concern are like bullies
who would scare small children around a campfire for our own amusement. Inflation is dead, now and forever, says the
twice a week New York Times Columnist.
His assertion will look odd to you if you have been in a grocery store
lately, but it grows positively loopy if you’re currently paying for a
Princeton undergraduate. Nothing on that
campus is going up at a 2% annual rate, least of all tuition. Which might remind all of us how often in
politics things look different if you are signing the front of the check or the
back.
In thinking about what comes
after QE3, consider this. It currently
costs America comparatively little to service our debt , a little over $200
billion a year, because interest rates are so low. But that number will leap by something on the
order of $500 billion the next time interest rates revert to anything like historical
low norms. And it will be worsened still
more by the losses that the Fed will have on its mortgage and long bond
holdings. The Fed and the Treasury came
to an agreement that those losses would not be borne by the Fed, but would
instead flow through Treasury’s current year deficit. This was reported in January 2011 by Grant’s
Interest Rate Observer, and to our knowledge no place else. It is a disturbing agreement, partly because
it has the whiff of someone preparing to leave the scene of an accident. But even more, it means the next Fed
Chairman, if he only normalizes monetary policy, will be handing the political
system an incredible bill, wholly unexpected, about the size of the
Simpson-Bowles fix all by itself. And we
did not have the courage to implement that fix a year ago. Paul Volker is 6`7”; the next fellow is going
to have to be a lot bigger when inflation has to be tamed again.
