Saturday, January 22, 2011


I was asked by a friend what I thought about the US dollar and the Feds policy of quantitative easing (QE2). Here is my e-mail reply:


I think Bernanke did exactly the right thing when he pushed the Fed into QE2. Moreover, at least so far, QE2 is a success. How do I know? First, the dollar index is going down (and I think it has a good shot at 65 - but when QE stops the dollar will rally, and rally big time). Second, the yield on the US 10 year is going up while the tips spreads are pretty much unchanged. This shows the bond market is expecting more economic growth, not more inflation. Third, the US stock market is going up, also reflecting expectations of higher growth.

QE works by inflating asset prices (stocks, commodities, real estate and other real assets) which rise initially because investors re-balance their portfolios after they sell assets to the Fed. But rising asset prices encourage their production (real investment) and also make people more optimistic about the future (more bullish "animal spirits" to borrow Keynes' phrase). These last two effects boost economic growth if there is slack in the economy as there is now.



Unknown said...

Do you think QE3 is a foregone conclusion?

Carl Futia said...


No. That will depend on how the economy performs over the next few months.

Huba said...

But isn't quantitative easing just buying time?

fiona said...

I agree with Carl, and yes Huba, QE2 is buying time for the parts of the Virtuous Circle to work.

If the stock market rises, more money is in peoples' pockets, thus more spending, businesses doing better, and then hiring (and the purchasing of homes). More money also means more taxes which helps the Federal Government.

If our market is the leader in the world (no inflation, and most importantly a favorable monetary policy), more people will flock to the US market.
Here I think we could have a higher US dollar, keeping commodities in check, unless demand negates this).

I would think if the Dow rises substantially (which I think it will) QE3 will not be needed, but we should be very grateful to Bernanke and the President for taking such a forward looking policy - a nice change from the UK and Europe's draconian measures.

A much higher market also means our businesses have purchasing power, which will make America the undisputed world leader again.

Unknown said...


what about DEBT? please address this part of the equation to add an overall fairness to the picture.

Debt does not magically disappear...

CautiousTrader said...

I don't understand how QE2 can be billed as a success when the express purpose was to lower longer term rates. Is Bernanke trying to deceive us when he states that that is the purpose?

fiona said...

Now about debt.

Consider, you have some credit card debt, student loans etc., but you qualify to buy a house. You are taking on more debt, but then you also furnish the house - more debt again, but in the meanwhile you have set in motion homebuilding and peripheral industries in your one action.
You think of working from home as well or a second job - more stimulation.
Meanwhile the market is rising allowing your savings and pension plan to accrue, allowing you to repay your loans, and the government gets their share in taxes.
Now multiply your scenario by the US population, and you have the economy humming again, and the debt is repaid.

The flip side of this is taking the austerity route.
Really - you still have your loans, there is no purchasing, businesses are stagnant, market is down or flat at best, less taxes for the government, still the same debt but compounded, and unfunded pension plans.

Think which scenario you think best.

Aurelien said...

People might start to "feel" richer when the market goes up thanks to QE2, but if they all tried to take advantage of the additional "wealth" by selling some stock/bonds to pay off their debt, then the market would fall again and most people would lose that perceived "wealth".

pimaCanyon said...

Carl lists "the dollar index is going down" as one of the benefits of QE.

I think that is a mater of perspective. That is a benefit if you're a corporation selling your products to foreign markets, but for the average American, that would be a negative effect, no? Imported goods (pretty much everything on the shelves of stores nowadays) now cost more and spending time in a foreign country also costs more.

pimaCanyon said...

I also wonder about Americans feeling "richer" as a benefit. That would be a benefit only if you own a stock portfolio.

Turns out only 1 in 3 US households owns a stock portfolio worth more than $10,000. That means that 2/3's of American households do not get to enjoy this benefit of QE. Seems to me this large majority of US citizens will get to experience only the negative effects of QE, namely rising prices.