Tuesday, October 26, 2010

El-Erian: Fed's QE Will Not Lower Unemployment And Will Cause Commodities to Rise

Mohamed A. El-Erian, chief executive officer at Pacific Investment Management Co, says the Federal Reserve Treasury purchases will probably not lower unemployment, while it will cause global inflation. He added that QE (Quantitative easing), will not be enough to deliver high economic growth.

Goldman Sachs estimates the next round of QE (QE2) at $2T. Then there may be QE3, QE4, etc, really devaluing the USD dollar for good.

In addition, he commented on the huge, record amount of U.S. debt, saying it is another problem for the economy.

“One thing that the Fed cannot do is stand still, it is terrified of deflation,” “QE on its own means we’ll have the same issues in six to nine months time with the rest of the world being inflated.”

“If I were to design the right policy response and implement it, it would be a package that would include structural reforms making us more competitive and the economy more flexible, more safety nets,”

On commodities, he says that new QE measures and  Treasury purchases will drive commodity prices even higher "as much of the money added to the U.S. economy spreads to other nations".

Of course, the Fed is now in an impossible situation that it itself caused. It pretty much announced QE. If it does not deliver, the markets will crash. And QE will likely not work.

Actual interest rates too high

By buying more bonds and treasury assets the objective is to lower real rates. Although nominal rates are very low, because there is zero inflation, or even deflation, the actual interest rates are too high. The Fed wants to increase inflation and therefore, reduce the cost of borrowing in real terms.

"The goal is to unlock consumer spending and jump-start an economy that’s growing too slowly to push unemployment lower".

Negative Yield

The Treasury sold $10 billion of five-year Treasury Inflation Protected Securities at a negative yield for the first time at a U.S. debt auction yesterday as investors bet the Fed will be successful in sparking inflation. The securities drew a yield of negative 0.55 percent.
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