- The Washington Times - Wednesday, November 3, 2010

The Federal Reserve on Wednesday made good on its promise to try to spur faster economic growth through a controversial program to purchase about $900 billion in Treasury bonds — nearly half the amount issued to finance this year’s federal deficit.

The program aims to force further reductions in the interest rates on mortgages and other long-term loans that are tied to Treasury bonds, though those already are at record lows, to try to spark a healthier economic expansion and reduce unemployment.

But even before the central bank formally announced that it would print money to buy the federal government’s debt, it already had run into heavy criticism from global investors and conservatives at home for its potential to spark inflation by driving down the value of the dollar — a process that is well under way in global markets.

While putting the strength of the dollar at risk, these critics argue that the bond purchases will do very little to spur business investment or aid a collapsed housing market that seems destined to be weighted down with bad debt problems for years to come.

“This could be wishful thinking,” said Sung Won Sohn, professor at California State University at Channel Islands. While inflation is low and shouldn’t be a problem as long as the economy remains weak, “there is so much liquidity in the economy that additional liquidity may not do much,” he said.

Banks and corporations already have about $3 trillion in cash on hand that they aren’t spending or lending, while 30-year mortgage rates that already are at record lows of around 4.25 percent have done little to revive home sales.

“With about a third of the mortgages under water and a lethargic job market, an even lower mortgage rate may not do a lot of good to the housing market,” Mr. Sohn said.

Meanwhile, most businesses are operating at far less than capacity, and “may not want to spend money on [capacity-expanding investments], no matter how low the interest is,” he said. “You can lead a horse to water, but you can’t make him drink.”

Michael Pento, senior economist at Euro Pacific Capital, warned that the Fed’s move sets a dangerous precedent by essentially printing money to buy the U.S. government’s debt, ushering in significant risks for consumers and the economy.

“The Fed’s plan has only one predictable consequence: inflation,” he said.

“Indeed, it has already been remarkably successful in sending asset prices higher,” he said, noting that the prices of internationally traded commodities like oil and gold soared in anticipation of the Fed’s move.

Calling the plan a “snake-oil” remedy, Mr. Pento warned: “It will not be very long before the consumer acutely suffers from this dangerous policy.”

The Fed’s decision — which was well-telegraphed in speeches by Fed chairman Ben S. Bernanke — provoked a dissent from the most conservative member of the Fed’s rate-setting committee at a two-day-long meeting.

Kansas City Federal Reserve Bank President Thomas M. Hoenig said the risks of higher inflation and asset bubbles created by the surge of Fed-generated cash flowing into financial markets outweigh any potential benefit.

His concerns found resonance with the conservative leadership that will be taking over the House as a result of Tuesday’s elections.

“The Federal Reserve has entered uncharted territory,” said Rep. Mike Pence, Indiana Republican and outgoing House Republican Conference chairman. “Diluting the value of the dollar by continually increasing the supply of money poses an incalculable risk.”

Mr. Pence said Congress should “embrace pro-growth fiscal policies to stimulate our economy” and relieve pressure on the Fed to move on untested remedies. “The American people deserve a government that protects the purchasing power of the dollar.”

Ironically, while a principal criticism of the Fed’s move is it risks igniting inflation, that actually is one of the Fed’s goals, as the central bank views the current slump in the inflation rate to less than 1 percent for non-energy prices as posing a danger of deflation.

Alert to criticisms that it could spur inflation, the central bank said in a statement that it will closely monitor the program to determine whether it is working as planned to spur growth rather than unacceptably high prices.

The Fed outlined a program to buy $600 billion of long-term Treasury bonds or about $75 billion a month through March 2011 “to promote a stronger pace of economic recovery.”

When combined with a program announced Wednesday by the New York Federal Reserve Bank to reinvest maturing mortgage securities owned by the Fed in Treasury bonds, the program envisions a whopping $900 billion of Fed bond purchases in the next six months.

Many economists applauded the Fed’s move as bold and creative.

“We do not share the widespread skepticism that the Fed is pushing on a string,” said Joachim Fels, analyst at Morgan Stanley, noting that anticipation of the Fed move in financial markets already has gone a long way toward achieving the central bank’s goals of sparking a modest uptick in commodity prices and growth.

The Fed already proved last year as well as during the Great Depression that such unconventional measures are effective in supporting economic growth. Moreover, recent similar programs launched by Japan and the United Kingdom proved to be effective, he said.

“This time will be no different in our view,” he said.

Brian Bethune, an economist at IHS Global Insight, said recent reports showing an uptick in economic activity and employment last month show the Fed’s policy is already working.

“The economy is slowing digging itself out of a deep hole,” he said. “The Fed is making the right moves here to nudge the pace of digging up a little.”

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