The Drag of Debt Hinders the Fed's Fight Against Deflation

The Federal Reserve's third round of quantitative easing (QE3) may have already failed.

You see, the nation's huge debt trumps monetary policy.

A Barron's article points out the findings of authors Carmen Reinhart and Kenneth Rogoff. In their book, This Time is Different: Eight Centuries of Financial Folly, they note that when government debt reaches about 90% of gross domestic product, it slows rather than boosts growth. At that point, a central bank's effort to stimulate the economy will fall short.

Well, U.S. debt reached 100% of the nation's GDP in August, 2011!

Here's an excerpt from the Barron's article:

Ben Bernanke seems to be losing his battle with deflation, observes Walter J. Zimmerman, chief technical analyst for United-ICAP. So far, the Fed's scheme announced in September to buy $40 billion of mortgage-backed securities for however long it takes to lower unemployment has little to show for it. Quite to the contrary, market prices show the U.S. central bank has shown itself impotent in its fight against the undertow of deflation.

Global stocks and commodities are down significantly from their peaks reached in mid-September while the dollar has strengthened, he points out. That is contrary to the record of QE1 in 2009, QE2 in 2010 and so-called Operation Twist (the Fed's purchase of long-term Treasuries and offsetting sales of shorter-dated maturities) beginning in 2011. While the first two iterations of QE boosted stock and commodity prices and lowered the dollar significantly from their outset, the markets have done the opposite under QE3.

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