By Steve Beckner

SEOUL, S. KOREA – Although Federal Reserve Chairman Ben Bernanke is
not participating in the Group of 20 leaders summit, he is very much
here in spirit — perhaps more than he would like to be. The Fed’s Nov.
3 resumption of quantitative easing haunts these contentious meetings
because of its impact on the dollar and world markets. Fed officials
freely acknowledge the dollar exchange rate is one channel through which
the $600 billion QE2 will work, but deny it was their main motivation.

Despite the furor overly newly created dollars, QE2 cannot work
primarily by directly injecting money into the economy at this stage.
Although the Fed’s latest senior loan officers’ survey shows some
further easing of loan terms and standards, credit demand has weakened
and bank lending remains anemic. Banks prefer to hold vast excess
reserves at the Fed, resulting in minimal money growth. To the extent it
works, St. Louis Federal Reserve Bank President James Bullard told MNI
QE2 will spur economic activity and job creation by lowering real
interest rates. The money growth will come later after faster consumer
and business spending increases credit demand and bank credit expansion.

FOMC voter Bullard said QE2 will work with the usual six to nine
month lag. He said it can be adjusted “in either direction” depending on
how the economy performs, but said there are numerical targets or
triggers for judging whether more or less asset buying is needed.

Since the FOMC met, Chairman Ben Bernanke has repeatedly gone
public in his defense of QE2. He said high unemployment and disinflation
showed the need for the Fed “to do more” to fulfill its “dual mandate.”
He downplayed Q.E. as just another form of monetary policy. He said the
Fed is using “a different set of tools to achieve the same results.”

But that’s not how others see it. Fed Governor Kevin Warsh voted
for QE2, but later raised warning flags. “(E)xpanding the Fed’s balance
sheet is not a free option. There are significant risks that bear
careful monitoring by the FOMC. If the recent weakness in the dollar,
run-up in commodity prices, and other forward-looking indicators are
sustained and passed along into final prices, the Fed’s price stability
objective might no longer be a compelling policy rationale. In such a
case–even with the unemployment rate still high–the FOMC would have
cause to consider the path of policy. This is truer still if inflation
expectations increase materially…..”

“The Fed’s increased presence in the market for long-term Treasury
securities also poses nontrivial risks,” Warsh continued. “The Treasury
market is special. It plays a unique role in the global financial
system. It is a corollary to the dollar’s role as the world’s reserve
currency. The prices assigned to Treasury securities–the risk-free
rate–are the foundation from which the price of virtually every asset
in the world is calculated. As the Fed’s balance sheet expands, it
becomes more of a price maker than a price taker in the Treasury market.
And if market participants come to doubt these prices–or their reliance
on these prices proves fleeting–risk premiums across asset classes and
geographies could move unexpectedly….(T)he Fed’s expanded
participation in the long-term Treasury market also runs the more subtle
risk of obfuscating price signals about total U.S. indebtedness….”

Dallas Fed President Richard Fisher, a 2011 voter who opposed QE2
before the FOMC meeting, continued to do so afterward. “I asked that the
FOMC consider that we might be prescribing the wrong medicine for the
ailment from which our economy is suffering,” he said. “Liquidity and
abundant money are not the binding constraints on the economic activity
we wish to see. The binding constraints are uncertainty about income and
future aggregate demand, the disincentives fiscal and regulatory policy
impose on ridding decisionmakers of that uncertainty, and the
reluctance, given those disincentives, of those who have the power to
create jobs for our people to invest in undertakings that would create
them. The remedy for what ails the economy is, in my view, in the hands
of the fiscal and regulatory authorities, not the Fed.”

[TOPICS: M$U$$$,M$$BR$,MMUFE$]