Federal Reserve policymakers' decision on Tuesday to buy more Treasury debt as interest rates stay at historic lows may give the U.S. economy the stimulus it needs, but it also may help contribute to a growing Treasury bubble that analysts fear will lead to the next market collapse.
Thomas Hoenig, the lone dissenter against the Federal Open Market Committee's decision, has spent the summer expressing his view that the FOMC's policy of keeping interest rates at exceptionally low levels is no longer necessary. Fed Chairman Ben Bernanke and most FOMC members, on the other hand, anticipate that economic conditions, including low resource utilization and stable inflation expectations, require "exceptionally low" interest rate levels for an extended period.
"Given economic and financial conditions, Mr. Hoenig did not believe that keeping constant the size of the Federal Reserve's holdings of longer-term securities at their current level was required to support a return to the Committee's policy objectives," said the FOMC's Tuesday statement.
In other words, Hoenig is worried that the record low fed funds rate of zero to 0.25% is too low because the nation's economy is in a modest recovery. Plus, the FOMC's plan to inject liquidity into the economy by buying more Treasuries and printing more money is flawed, he believes, because it will lead to inflation.
Possible $1 Trillion Price Tag on Quantitative Easing
Yes, inflation. Although deflation worries have ruled the financial news this year, the new buzz among economists and other Fed followers is that the next big market disaster could very well be a rise in inflation fueled by a growing Treasury bubble that eventually collapses under its own weight.
That bubble, they say, is now in the process of being created because the Fed may soon resort once again to using something called "quantitative easing," which means using repayments on debts such as mortgage-backed securities to buy long-term Treasuries–to the tune of $1 trillion.
"Ben Bernanke knows the ball's in his court. His tool is quantitative easing," said Thornburg Value Fund co-portfolio manager Edward Maran in a talk about the domestic and international stock markets Wednesday at the 21 Club in midtown Manhattan. "We've got a reflationary environment coming, so with Ben Bernanke, it's going to be shock and awe. Expect to see trillions rather than billions. It's going to be substantial."
Maran and other analysts expect the Fed's major asset buyback to happen sometime around year-end 2010 or early 2011.
Jeff Kleintop, chief market strategist for independent broker-dealer LPL Financial in Boston, agreed with Maran's assessment, putting the quantitative-easing price tag at somewhere between $500 billion to $1 trillion.
Big Money Required 'To Really Move the Needle'
