It's worth taking a look at what the Fed's up to and what the Fed's balance sheet looks like (go to page 6 for it on the PDF). This will help counter some of Ron Paul's more outre rhetoric and give a whoa-mule two-by-four to some of the more desperate moves of the Fed.
Our US currency is largely backed up by... US debt. The Fed owns about $2 trillion in US debt on its balance sheet of $2.427 billion in assets. The liability side has $941 billion in currency, $1.3 trillion in deposits from banks and Uncle Sam, about $200 billion in other stuff and $53 billion in equity.
Here's Ron Paul from the last presidential debate
We owe the Fed $1.6 trillion in treasury bills. Where'd they get the money to buy it? They created it out of thin air. So we pay them interest. Now that's on our books. So we literally, with legislation, could wipe $1.6 trillion off that is not a solution to the monetary problem or our spending problems, but it would give you a year to work this out.
The figure is closer to $1.0 trillion in pure Treasuries and another trillion in government-sponsored debt (Fannie Mae and Freddie Mac most likely), but the concept is still in play. The balance sheet I referenced was from Jan 1, so we might be a bit higher now.
Were we to take the advice of Paul and just repudiate that debt, the dollar would be worth about 20 cents of what it is worth today, since the Fed would have about $400 billion of assets to cover $2.37 billion of liabilities. That's about 16 cents on the dollar.
What it would create is hyperinflation, as we would see prices rise roughly 600% overnight given the decreased value of the remaining Fed balance sheet. If Ben Bernanke's safety in Texas was questioned by Gov Perry after doing QE3, a President Paul would be need bullet-proof undies 24/7 if he tried to pull that, for the resulting chaos would... at least make for a very interesting poli-fi novel.
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Meanwhile, back to reality as we know it. Washington and the Fed have very little tools in the arsenal for stimulus. Fiscal policy is largely moot given the huge deficits; there is little room for any big tax cuts or spending programs when the lean is towards reining in deficit spending. Standard monetary policy is largely moot as well, as short term interest rates border on zero; we've hit what economists call a liquidity trap, where any extra money pumped into the banking system just sits there.
Normally, the Fed buys short-term Treasury bills as part of its balance sheet, buying them to add to the money supply and selling them to take money out. However, since short-term interest rates are at zero, the Fed has been playing with buying longer-term Treasuries and other long-term debt in order to try and bring long-term rates down as well; higher bond prices mean lower interest rates, as the two go in opposite directions. In theory, the lower rates will lower corporate cost of capital and make marginal projects worth doing at a lower CoC.
"Quantitative easing" is the new buzzword for that strategy. The Fed has done two rounds of that, with the second tranche getting the shorthand QE2, likely as a nod to the luxury liner and/or her royal namesake. A proposed third batch thus gets the shorthand QE3; that's the policy that has Rick Perry hot and bothered.
Why is QE3 dangerous? If we do have a return of inflation, it may do to the Fed's balance sheet by accident what Paul would do on purpose. High inflation leads to higher interest rates and... lower values of existing bonds, since as I mentioned earlier, interest rates and bond prices are on a teeter-totter. Short-term securities don't lose much in value, but the longer the term, the more sensitive it is to interest rates.
The Fed could easily find itself where a lot of banks were back in 2008, with negative equity due to a drop in value of its portfolio.
Bernanke and company want to do something. However, we're at a point where the Fed can't do much without compromising its core function of maintaining a stable dollar and a stable financial system. Washington can't do much, either.
The economy is going to need to get out of this largely on its own; lowering the regulatory burden on businesses, especially including ditching "Obamacare", would be a net plus, but fiscal and monetary policy have emptied their barrels at present and have no good ammo left.
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