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QE and Interest Rates

Wednesday, August 24, 2011
Michael Pento

The market has rallied on the hopes of more QE emanating from Bernanke at Jackson Hole. However, one has to ask what good would it do? Interest rates are already profoundly negative and nominal rates are at all time lows. The money supply as measured by M2 is booming at a 20% annualized rate and inflation at the consumer level is up 3.6% YOY—far ahead of Bernanke’s 2% target. And banks already have $1.6 trillion of excess reserves if they need them. My guess is he may lower the interest rate on excess reserves so banks would be forced to lend more money and its supply would increase yet faster. But this is a balance sheet recession and can’t be helped by crumbling the currency and increasing inflation.

By the way, since I write a blog, it is my great pleasure to expose economic voodoo whenever and wherever I find it. There are some bubblegum-economists and money managers who espouse the belief that the Fed—and indeed all central banks—have absolute control over interest rates. But this is simply not true. A central bank targets the cost of borrowing, but cannot determine in absolute terms what the market rate will yield. To prove my point, let’s look at Europe. The ECB has pegged their benchmark lending rate at 1.5%. But the last time I checked, Greece was in the European Union (17) and yet had a borrowing cost of 40% on a 2 year note!

The only way a central bank could control sovereign debt yields would be to buy all that is issued. Of course, the massive inflation created would send yields on every other form of borrowing to the clouds. So the next time you hear someone say that the Fed can buy debt and thus mandate the level of all interest rates; just tell them yes they can, but only for a little while.