QE2 – What Is It Supposed To Do?

Are you confused about what QE 2 is supposed to accomplish? If so, please don’t blame yourself. According to our economy’s ‘doctors,’ QE2 is supposed to cure everything from asthma to zebra-itis!

Not since “friendly fire” has there been a euphemism shrouded in obfuscation like “quantitative easing”! Here, straight from the London Financial Times and the Wall Street Journal are ten completely conflicting explanations of what QE2 might  – or might not –  do.

(1) Fight Scylla (deflation) — with Charbydis (inflation)?

Deflation “Many outside the Fed… see the move [QE2] as a ‘Hail Mary’ pass by Fed Chairman Bernanke” as “he confronts an economy hobbled by… the threat of a Japan-like period of deflation…” (John Hilsenrath, Wall Street Journal 11/4/10 A1+A15)

or Inflation “For much of the past generation, Federal Reserve officials have been focused on an overarching long-run goal; Get inflation down and keep it there. Now Fed officials want to get inflation a bit higher.” (Jon Hilsenrath, Wall Street Journal 10/25/10 A6)

or Manipulation of Perceptions of Inflation and Deflation “Inflation expectations from bonds and bond futures have soared since QE2 was put on the agenda at the end of August. But this has merely eliminated the perceived risk of deflation, exactly as the Fed wants.” (James Mackintosh, Financial Times 11/2/10 p 7)

[Ah! The Fed navigates nicely between a rock and a hard place.]

(2) Liven up the US economy? – or re-leverage it with risky investments?

Party on! “‘What the Fed is trying to do is re-ignite the animal spirits of the economy,’ said Rob Arnott, chairman of Research Affiliates LLC…” (Mark Gongloff, Wall Street Journal 11/5/10 A1+A6)

“The Fed’s aim is to drive up the prices of long-term bonds, which in turn would push down long-term interest rates. It hopes that would spur more investment and spending and liven up the recovery.” (Jim Hilsenrath and Jonathan Cheng, Wall Street Journal 10/27/10 A1)

But have no fear! “The Fed figures it [QE2] will also drive investors into stocks, corporate bonds and other riskier investments offering higher returns.” (John Hilsenrath, Wall Street Journal 11/4/10 A1+A15)

[Spend more money on pricier assets! Great idea! But didn’t we already try that—right before the financial crisis?]

(3) Give the “fat cats” a boost – or save their butts?

Boost butts “‘The no-asset-market-left-behind approach is officially endorsed,’ said Steven Englander, a Citigroup Analyst.” {when bond, stock, and commodity prices all rose after QE2 was announced] (Alan Beatie, Jennifer Hughes, and Kevin Brown, Financial Times 11/5/10 p 1)

or Save butts “Some respected investors, including David Tepper, the billionaire hedge fund investor…have publicly extolled the virtue of a ‘Bernanke put’ for the stock market.

Mr. Tepper has taken to the airways arguing that, should the economy weaken further, then the Fed’s embrace of renewed monetary easing should protect equities from the risk of losses.” (Michael Mackenzie and David Oakley, Financial Times 10/9–10/10 p15)

[Oh wow, looks like the stock market is now too big to fail too!]

(4) Solve the mortgage mess — well, maybe?

“Lower mortgage rates will prompt homeowners to refinance…Mr. Bernanke wrote.” (Robin Harding (Financial Times 11/5/10 p 2)

“QE2’s challenge is to encourage spending and activate a housing market that remains moribund, even though – thanks in part to QE1 – houses have never been so affordable.” (Financial Times 11/2/10 p16)

(5) It’s either a sneaky way to devalue the US dollar and sell more exports than China — or it’s a sneaky way to substitute monetary stimulus for fiscal stimulus, without anyone knowing.

The currency conspiracy

“The US is pursuing a policy of weakening its currency which is driving up exchange rates in the rest of the world, according to Alan Greenspan, the former chairman of the Federal Reserve.” (Alan Beattie, Financial Times 11/10/10)

“By contrast [to direct methods of devaluing a currency] massive asset purchases [of its own bonds by US government] are a more indirect way to drive down a currency, while avoiding criticism precisely because quantitative easing doesn’t directly target currency levels.” (Henny Sender, Financial Times 10/9–10/10)

[So, Alan Greenspan, former head of the Fed, is now a whistleblower?]

The stimulus-substitution conspiracy “The move [to QE2] is probably the last chance to boost economic growth … as there is little chance that the new divided Congress will agree to further fiscal stimulus.” (Robin Harding, Michael Mackenzie, and James Politi, Financial Times 11/4/10 p1)

“By providing huge additional demand for assets such as government bonds, QE can raise their price and thereby bring down the interest cost of long-term borrowing. The aim is to spur investment and spending today.” (Chris Giles, Financial Times 10/5/10 p 11)

“On its [QE2’s] success rests both the reputation of Ben Bernanke, the Fed chairman, and the chances that the US can avoid a decade of weak growth.” (Robin Harding, Financial Times 11/1/10 p 3)

[Yeah, Barak, let’s do that stimulus thing again! The big banks and corporations didn’t get enough the first time around! I bet this will make ’em spend that cash they’ve got stashed.]

(6) Improve Ben Bernanke’s golf, uh, I mean, economic game

“Mr. Bernanke has used the analogy of a golfer with a new putter: Unsure how it will work, he finds the best strategy is to tap lightly at first and keep tapping until the golfer figures out how best to use the putter.” (Jim Hilsenrath and Jonathan Cheng, Wall Street Journal 10/27/10 A1+A6)

[note: this refers to the Fed’s plan to dole out unspecified quantities of new money in unspecified dribs and drabs over an unspecified period of time]

(7) Bail out the US government — or destroy it for good?

Deliverance “The Fed is essentially lending enough money to the government to fund its operations for several months, something called ‘monetizing the debt.'” (John Hilsenrath, Wall Street Journal 11/5/10 A6)

“[QE2] suggests an intriguing possibility: a government could lower its borrowing costs by getting the central bank [the Fed] to create a perpetual bull market in all sorts of bonds.” (Edward Hadas, Financial Times 10/3/10 p 18)

or Eve of Destruction “Jan Hatzius and colleagues at Goldman Sachs use a Taylor rule to estimate that $4,000 billion [$4 trillion] of QE2 may be needed and that the FOMC [the Fed’s Open Market Committee] might buy $2,000 billion [$2 trillion] of [QE2] assets.” (Robin Harding Financial Times 11/5/10 p 2)

[note: the US deficit stood at $1.3 trillion as of Nov 1 2010. Uh, wouldn’t a $2 trillion cure be worse than the disease?]

(8) It’ll finally get rid of that pesky 9.6% unemployment! Oh, please, please!

“The move [to QE2] is probably the last chance to boost economic growth and tackle the 9.6 percent US unemployment rate…” (Robin Harding, Michael Mackenzie, and James Politi, Financial Times 11/4/10 p1)

“So the Fed is likely to do something – anything – to speed progress on those fronts [economic growth and unemployment].” (Kelly Evans on why the Fed is pursuing QE2, Wall Street Journal 11/3/10 C1)

(9) Proves conclusively economists can’t agree on anything?

“He [Milton Friedman] believed in the potency of ‘quantitative easing,’ or QE – printing money to buy bonds… The Friedman logic…makes the case for QE2.” (David Wessel, Wall Street Journal 10/28/10)

“Some people, including this newspaper’s David Wessel in a column last week, believe the great Nobel laureate [Milton Friedman] would favor this inflationary program [QE2]. I am certain he would not.” (Allan H. Meltzer, Wall Street Journal 11/4/10 A21)

(10) Is it just confusion – or is it a criminal affair?

“Ahead of this meeting, no less than 10 FOMC [Federal Open Market Committee] members have staked out public positions on QE2, some of them poles apart. This would not be a problem if the FOMC made its decisions by a simple majority… but, at the Fed, any more than one or two dissenting votes is unacceptable.

The FOMC still defers to Mr. Bernanke [because he’s a monetary expert and favors QE2] but…they give weight to every minority view.” (Robin Harding, Financial Times 11/1/10 p 2)

“’Cheque writing in the trillions is not a bondholder’s friend; it is, in fact, inflationary, and, if truth be told, somewhat of a Ponzi scheme,’ [emphasis mine] says Bill Gross, founder and managing director at Pimco.” (Michael Mackenzie, Financial Times, 10/29/2010)

[note: rumor in DC has it that SEC officials, stung by their failure to spot Mr Madoff’s scheme quickly enough, will soon be dropping in for a friendly chat with Mr. Bernanke about exactly how QE2 works… Stay tuned!]