Tuesday, November 9, 2010

The market gives a big thumbs-down to QE2


There is a rising, worldwide tide of protest against the Fed's decision to proceed with QE2. Today's WSJ has an excellent op-ed on the subject, which included an insightful quote from Sarah Palin: "We don't want temporary, artificial economic growth brought at the expense of permanently higher inflation which will erode the value of our incomes and our savings." That captures the essence of the layman's QE2 concerns.

The chart above shows that the bond market is protesting as well. 30-yr bonds—which are quite beyond the scope of the Fed's planned bond purchases, and generally immune to Fed manipulation in any event—have been marching steadily higher in yield (and lower in price) ever since late August, when the Fed began pre-announcing its intention to proceed with QE2. Quite simply, the bond market is telling us that QE2 will indeed accomplish its stated objective of increasing inflation. Gold, trading today at over $1400/oz., is also telling us that QE2 will prove inflationary. Industrial commodity prices are at all-times high as well, and the dollar is at or near all-time lows against other currencies.

The issue now becomes this: how long will the Fed ignore the growing number of market signals that its proposed QE2 is not a good idea? Dissension among the Fed governors is growing, and I note Kevin Warsh's op-ed in the WSJ the other day as being particularly well thought out. Encouragingly, he makes it clear that the only rational way to stimulate the economy is through the supply-side, not with monetary policy:

The U.S. and world economies urgently need stronger growth, and the adoption of pro-growth economic policies would strengthen incentives to invest in capital and labor over the horizon, paving the way for robust job-creation and higher living standards.
Pro-growth policies include reform of the tax code to make it simpler, more transparent and more conducive to long-term investment. These policies also include real regulatory reform so that firms—financial and otherwise—know the rules, and then succeed or fail. 
I think Bernanke must be a very nervous man these days. He is determined not to let deflation show up on his watch. But I doubt whether he is going to plunge ahead with QE2 in the face of mounting opposition to inflationary policies, and mounting evidence that deflation and a liquidity shortage are the least of the economy's problems at this juncture. I think that when push comes to shove we are going to see that QE2 is a conditional policy objective, not cast in stone. It can and most likely will be shut down or put on hold before too long.

18 comments:

Benjamin said...

I see the thug Russians and the commie Chinese are sniveling about QE2. Oh, those are such free-market economies.
Germany too--the socialist paradise, and Brazil, where they want to make nice to Iran.
Why are the reactions of these states worth mentioning, when they are usually cast as global lowlife by the WSJ?
Bernanke knows of what he speaks. He will proceed with QE2 as it is best for America, not the commie Chinese or the thug Russians, or socialist paradise Germany.

It is sad that some QE2 has become seen as a left-wing idea. It is exactly the policy that Milton Friedman adovocated for Japan.

I suspect if QE had happened on Bush's watch, and it was presented as necessary to support our wars in Iraqistan, it would be greeted with open arms by the right.

Stick with Friedman--he rises above party dogmas, and delivers true classic economic advice.

Jake said...

not sure i agree that "the market" can be defined by one segment of one market that was not targeted by QEII. since QEII's announcement equities, commodities, risk-sector fixed income (corporates, high yield, CMBS, non-agency MBS), and even treasuries with maturities between 0-8 years are up. perhaps you should change the title to "only one market gives a big thumbs-down to QE2"

the goal of QEII is to "re-inflate" asset prices. while i don't agree with QEII, this does mean inflation expectations would also be re-inflated, which should aversely impact long treasuries (which were not targeted in the fed's statement).

SPN Headlines said...

Palin debuts another money-making venture, a consumer rating guide called "Sarah's Scores" - REVEALING story at:

http://spnheadlines.blogspot.com/2010/05/palin-pushes-new-ratings-guide-sarahs.html

Peace! :-)

Bill said...

I really hope you're not looking to Sarah Palin for leadership on these issues. I recommend Peggy Noonan's article the other day in the WSJ where she points out that competence matters. She is a disaster for the Republican party.

septizoniom said...

excellent post. plus, the fed is conducting fiscal policy since post lehman directly in contravention of the federal reserve act and the constitution.

OM2LTD said...

Let's see what the WSJ thinks of Palin's editorial.



Palin Responds to Real Time Economics and We Respond




Hmmm. A little off on the facts. The implication that Sarah Palin has some understanding of economics at any level I find to be unlikely.

I've never heard her make an unscripted insightful comment about economics that would lead me to believe she has any knowledge of the subject whatsoever.

Public Library said...

The world is getting more USD regardless of what anyone says.

Bernanke was destined for this moment...

brodero said...

The average SAT score of the first college attended by Sarah Palin : 975

The average SAT score of the first college attended by Ben Bernanke : 1494

( actually Ben made 1590 out of 1600....there are rumors of Sarah Palin's actual SAT)

Scary..if we are looking to Sarah Palin for monetary guidance
surely the Tea Party can come up with somebody better.

The Lantern said...

Um, Sarah, inflation can help incomes also. That's why there is the term "wage inflation". This normally appears when unemployment is not 10%.

Not too many companies borrow at 30 year rates, and even 30 year mortgages are priced off of the 10 year rate, not the 30 year rate because people move/refinance. I don't think the Fed cares too much about 30 year rates. Shorter term rates have come down and so, in that sense, QE has already been "successful". Whether it contributes to lower unemployment or higher growth is hard to say and smart people would disagree. One thing that we should agree on is that Sarah Palin is not qualified to be in that debate and should not be saying anything about QE2.

REW said...

The response of equities to QE2 has also been negative, in real terms. The value of equities, valued in gold, not dollars, is down since the August QE2 pre-announcements.

Charles said...

Sarah Palin understands far more about economics than Barack Obama. That doesn't mean she is qualified to be president or makes a viable candidate. We have been damaged enough by the media star presidency we are now enduring. As far as SAT scores are concerned, there is no doubt that Herbert Hoover and Jimmy Carter were "smarter" than Ronald Reagan.

Bernanke was an academic economist. He has a deep historical understanding of the great depression. The problem seems to be that he views our situation through the prism of his narrow specialty.

America is not Japan. And while it is true that central bank incompetence can generate deflation, deflation in Japan is a consequence of profound structural problems that the Japanese refuse to deal with and/or cannot deal with. There is no deflation in the US. There is no sign that monetary policy is deflationary.

As far as QE2 is concerned, I see no reason to believe that it will have any effect at all except to spook foreign governments and give false encouragement to the stock market. The dollar enjoys reserve currency status. America stands to lose if the fed behaves like the central bank of Honduras and drives away our major customers.

Dr William J McKibbin said...

I maintain that the only practical approach (as in publically supportable) to reducing the national debt and entitlements is through monetary expansion (and inflation), which is what the Fed just did in what we know as "QE." Keep in mind that inflation carries less risk than deflation, and frankly, the public and Congress will never consent to drastic spending cuts that are necessary at this point.

If inflation were to take the course of the period 1973-1982, the US could reduce its national debt and entitlements spending across the board by a whopping 85%! Neither the Republicans nor the Democrarts would ever agree to legislation that would accomplish the same using spending cuts, tax increases.

Rand Paul recently called for a 5% across the board cut in government spending, but his proposal is not being taken seriously by the masses or even a majority in Congress. This lack of public and Congressional support for what is required and necessary to reduce the national debt and entitlements is instructive.

Ironically, the inflation route requires no such mandate as the Federal Reserve can create inflation without the approval or consent of Congress, the President, or the public. US fiscal policy has failed America - the only hope for the future is drastic monetary actions by the Federal Reserve.

A period of inflation would be the most expeditious route to reducing the national debt and entitlements by half or more within a decade. More at:

Using Inflatoin to Reduce Public Debt and Rout Entitlements

By the way, equities perform nicely during times of inflation. Thank you for the opportunity to comment.

Dr William J McKibbin said...

PS: The US has already experienced inflation like I describe above during my lifetime. An inflationary correction in the US is a far more believable and practical fix then spending cuts and tax increases, which will never pass Congress at the levels necessary to restore the US economy. The economic pain is coming one way or another -- inflation is the least painful approach for most people in America -- more about the US inflation experience at:

How High Can Inflation Go...?

Thank you again for the opportunity to comment...

brodero said...

Reagan was a lot smarter than
Sarah Palin....Sarah Palin is no
Ronald Reagan....we can do a lot better

Paul said...

I always find it interesting how the concentration of Palin haters is made up of people who voted for Obama. Palin doesn't have an Ivy League education, she's not an economist, but at least she was smart enough to accurately predict the utter disaster of our community organizer President.

brodero said...

I liked Nixon,Ford,Reagan,Bush1....there are so many republicans
that are better qualified than Sarah Palin....the dumbing down of America....Reagan ran a Huge economy ( California and served 2 terms)....Palin served a half a term in a very small state...

Bill said...

Paul,

I don't think Palin was the only non-Ivy league politician who predicted the disaster that is the Obama administration. Can you honestly look at her background and decision to drop out before finishing her term in Alaska and say that she is the one who should lead the Republican party?

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