The Guest Blog

Morici: Federal Reserve Ending QE2: Much Ado about Nothing

The Federal Reserve will soon conclude its $600 billion in bond purchases. Not much will happen, because QE2 was as inconsequential as one hand clapping.

Monetary policy-suppressing the Federal Funds rates or long rates through QE2-does not have much impact if big U.S. companies are already flush with trillions in cash but don't want to invest and hire, and moderate sized businesses can't get loans because regional banks can't borrow from large Wall Street Banks to get enough access to all that Fed manufactured liquidity.

More fundamentally, investment and hiring are not taking off because demand is weak for what Americans make. Until the beginning of this year, consumer spending was taking off but too many dollars were going into imported consumer goods that did not return to purchase U.S. exports, and more recently, that problem has been exacerbated by the high cost of imported oil and gasoline.

Money that goes into the gas tank ends up in pockets of Saudi princes where it does Americans little good, and money that goes to China for cheap stuff at Wal-Mart only subsidizes more underpriced imports and Beijing's grab of resource properties in places like Australia and Africa.

Since the beginning of the economic recovery in mid 2009, the trade deficit has jumped from $320 billion to about $570 billion in the first quarter. With the trade gap exceeding 3 percent of GDP, either Americans borrow and spend more than they earn to keep the economy going, or the demand for U.S. made goods and services is insufficient to accomplish full employment.

Too many Americans can't find decent paying jobs, houses don't sell and prices stay depressed, and consumers are now falling off into a new sense of defeatism. In the funk, unemployment stays above 9 percent, and counting adults stuck in part-time jobs or too discouraged to look, and young college graduates flipping hamburgers, it is closer to 20 percent.

Oil and goods from China account for the entire U.S. trade deficit-on everything else, trade is balanced.

The United States produces only 5.6 million barrels a day of oil and imports 9.6 million barrels-gasoline accounts for 8.3 million barrels. The United States could easily increase domestic production by 3 or 4 million barrels a day over several years and slice 2 million barrels off fuel consumption by using readily available, more fuel efficient internal combustion engines and plug in hybrids, and further deploying domestic natural gas use.

Drilling in the United States is an anathema to Democrats, owing to environmental concerns, but not drilling and importing what oil is needed merely shifts environmental hazards abroad-mostly to developing countries-where those are handled less effectively. If American environmentalists really believe in thinking globally and acting locally, they should get behind domestic drilling if it is coupled with a program to substantially reduce domestic gasoline use.

Curtailing gasoline use will be a bitter pill for Republicans-more government intervention in the form of higher mileage standards and assistance to automakers to more rapidly transform their factories. Fanciful investments in electric cars are nice-but electric solutions put in place by the Obama Administration won't generate sufficient reductions in gasoline use for at least a decade.

Driving won't be any cheaper-gas prices would not be much lower and money to aid industrial transformation must be taken from other places-but both policies would keep the money Americans spend on imported oil at home, create high paying jobs and get the economy growing again.

Beijing engages in quantitative easing on a grand scale-hogging growth and exporting inflation. It is time to recognize what it does-currency manipulation and protectionism to gain competitive advantage-and address it forthrightly.

Each year, China maintains an undervalued currency by printing yuan to purchase about $450 billion in dollars and other foreign currencies. This reduces domestic Chinese consumption and places a 35 percent subsidy on Chinese exports, accelerates investment and jobs creation in China, and suppresses growth in the United States and Europe, which contributes importantly to sovereign debt problems on both sides of the Atlantic.

China also uses those yuan to subsidize purchases of oil and other scarce commodities it lacks, creating global inflation.

Stagflation results-slower growth and more inflation in the United States and Europe.

Diplomacy has failed to persuade China to relent-raising the value of its currency 10 percent doesn't do much good when the intrinsic value of the yuan continues to rise, and it remains undervalued by several multiples of 10 percent.

The solution is to impose a tax on the conversion of dollars into yuan, either for the purpose of importing Chinese goods or investing in China, equal to China's currency market intervention divided by its exports-35 percent. The EU could do the same, if it likes, on euro-yuan conversions.

When Beijing stops intervening, the tax stops. In the meantime, prices that drive investment and jobs creation would be more closely aligned with those that would prevail absent Chinese currency market manipulation and protectionism. Those would be free trade prices.

That tax bothers everyone but look outside.

America is collapsing. China's currency market intervention is destroying the U.S. industrial base, thrusting millions into unemployment, driving up global energy consumption and pollution, and undermining the free trade system that took half a century to build.

Free trade is great stuff, and Americans should want to compete with Chinese workers on that basis-both countries would grow. But with China's currency manipulation unanswered, it's like wrestling bare handed with an opponent holding an axe.

China continues to grow and will soon overtake the United States. Yet, U.S. politicians and pundits argue about spending cuts and tax increases, when neither will help us avoid the immediate threat of a double dip recession or ultimately the decline of America.

Then whose example will the struggling nations of Asia and Africa aspire? America's democracy or China's autocracy?

The steps outlined are extraordinary and are hardly in the American tradition of free markets and private enterprise-but America is confronted by challenges and threats to its prosperity and democracy on a scale not seen since the Great Depression and World War II.

Extraordinary times require actions to match.

Peter Morici is a professor at the Smith School of Business, University of Maryland, and former Chief Economist at the U.S. International Trade Commission.