The Emerging Headache of QE3
The Fed has promised to purchase US$ 40 billion worth of mortgage-backed
securities (MBS) per month until it is satisfied with the economy. By all
accounts an unemployment rate above 7 percent is not satisfactory to the Fed.
Its own analysis doesn't expect the unemployment rate to fall below 7 percent in
two years. That suggests that QE3 will last for over two years, and the total
amount of MBS purchases will exceed $1 trillion, more than QE1's US$ 1
Through its purchases of MBS, the Fed provides direct support to the housing market and banks. The housing market is still wobbly. No economic recovery can be strong without a strong housing market. The Fed's purchases will narrow the spread between the treasury yield and housing financing cost. The 10-year treasury yield is 1.8 percent. If the mortgage interest rate is decreased to such a level, it provides ample refinancing opportunity, which alleviates the debt burden for the heavily indebted household sector.
The United States' household sector is US$ 12.9 trillion in debt, down nearly US$ 1 trillion from the peak, partly through bankruptcies. The pressure for reducing the debt is considerable. It is a major factor in keeping the economy weak. Through decreasing the interest burden, QE3 is likely to lessen the deleveraging pressure.
The United States' household real estate value has declined by 30 percent from the peak in 2006. The current aggregate value of US$ 16 trillion is slightly above 100 percent of GDP and still high by historical standards. If the market adjusts naturally, it may well fall another 30 percent. The Fed's actions so far have decreased its decline. QE3 is likely to continue this support. However, the artificial support can't reverse the trend. It merely allows the nominal GDP to grow while keeping housing value stable. It cushions the downturn, but also saps the recovery strength.
The Fed is unhappy with the strength of the economic recovery. It has itself to blame. The monetary and fiscal stimulus prevented a thorough cleansing of the inefficient economic activities that built up during the bubble economy. The economy didn't reach its natural bottom in the downturn. Therefore, the upturn is weak too. Many unproductive economic activities still take up a significant chunk of resources. Finance and health care, in particular, are still highly inefficient and take up nearly one-fourth of the economy. The Fed's monetary policy cannot substitute for structural reforms. QE3 will not create a strong economy.
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