Tuesday, April 12, 2011

Hoisington Q1 Letter

If the objectives of Quantitative Easing 2 (QE2) were to: a) raise interest rates; b) slow economic growth; c) encourage speculation, and d) eviscerate the standard of living of the average American family, then it has been enormously successful. Clearly, with the benefit of 20/20 hindsight these results represent the Federal Reserve’s impact on the U.S. economy, regardless of their claims to the contrary.

Why the Fed would believe the economy could benefit from the addition of $600 billion (the QE2 target) in reserves to a banking system that already had over $1.1 trillion in unused, idle, but potentially inflationary reserves on hand nearly defies understanding. The action, however, was not lost on holders of the $8 trillion Treasury securities outstanding.

This increase in the level of interest rates occurred, not only during QE2, but in QE1 as well (Table 1). Thus the Federal Reserve engineered a rate increase, and the injection of excess reserves had several other deleterious ramifications for the U.S. economy.


This QE2 episode serves as a reminder that the nature of the problems facing the economy are very complex, including a variety of deep seated structural problems such as excessive indebtedness, and an unstable and debilitating fiscal policy. The Fed’s freedom to act does not eliminate the need for wise decisions. Untested monetary solutions for non-monetary problems should not be attempted. Sympathy for high unemployment is not sufficient when Fed actions produce undesired feedback loops that increase misery. While the Fed has the dual mandate to keep inflation and unemployment low, the path to achieving those dual objectives is to base decisions on the inflationary implications of their policy. If the Fed’s goal is to limit unemployment, the path to success is to ensure low, not accelerating inflation, a lesson we have just learned once again.