Friday, November 12, 2010

The flogging will continue until morale improves

The Federal Reserve recently announced they will purchase another 600 Billion in US Treasury bonds (commonly called Quantitative Easing 2 or QE2)  I am working on a longer email regarding how our current financial situation is very different from previous recessions and recoveries but the Federal Reserve's QE 2 announcement deserved some commentary. 

The markets did not really respond until after reading Fed Chairman Ben Bernanke's article in the Washington Post on November 4:
For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.
In short Fed Chairman Ben Bernanke wants higher stock prices so you'll feel better about yourself and go buy more stuff.  
Will it work?  
I have my serious doubts (as I'll expand upon in later emails).   The banks already have so much unused money they deposit the excess at the Federal Reserve. (973 billion as of October 10)  How is another 600 billion going to change the situation? 

So why is the Fed printing? Because they can and they feel like they can't do anything else. It looks like an easy painless solution but in the long term it will not fix the problem of too much debt in America. 

The problem with QE2 is the money being created is not going where Mr. Bernanke would like it to, the real US economy.  If you look at the market's reaction before and after the announcement one sees the money shifting into commodities and emerging economies while simultaneously weakening the US dollar.   The Fed is taking the easy way out by attempting to prop up and paper over our structural problems.

Lest you think this is merely the ranting of a crazed financial advisor former Federal Reserve Chairman Paul Volcker stated the QE2 plan won't help much as well: (Yahoo, November 5, 2010)
Volcker told a business audience in Seoul that the Fed's bond plan is obviously an attempt to spur the U.S. economy but "is not the kind of action that's likely to change the general picture that I've described as slow and labored recovery over a period of time."
The Wall Street Journal (November 4, 2010) expresses caution as well:
The Fed is essentially lending enough money to the government to fund its operations for several months, something called "monetizing the debt."
In normal times, this is one of the great taboos of central banking because it is seen as a step toward spiraling inflation and because it risks encouraging reckless government spending.
Financial markets Thursday responded warmly to the Fed move, but outspoken critics of the policy issued full-throated critiques.
"It is doubtful the Fed decision will produce any results," Brazilian Finance Minister Guido Mantega told reporters following a cabinet meeting with Brazilian President Luiz Inacio Lula da Silva. Officials in Brazil, which averaged 850% annual inflation in the 1990s, have been critical of the Fed's easy-money policies because they are spurring price pressures abroad and could encourage new asset bubbles outside the U.S.
If all else fails, keep doing what you did before seems to be the rule at the Federal Reserve.  By his actions Ben Bernanke is attempting to artificially raise asset prices and reduce the value of the dollar.  We shall see if he is sucessful, but what happens when the crutch of QE money is removed? 


  1. great stuff greg.

    signed, bubble rider(boatman)

  2. Its going to get more interesting . . . .

  3. ireland was not even on the ECU bank reserve hit list if my memory serves me.

    he types as he stares at the DOW in disbelief and shakes his head.

    the bigger they are....the harder they______


  4. My fear is the inflationary merry go round will continue a bit longer. Chinese buy empty homes to hedge against inflation, which creates more inflation. Lather, rinse, repeat.

  5. 164 million empty condos in coastal china...a fact greg

  6. I wouldn't be surprised if it was more. The problem with shorting it is what if they build another 50 million?