Comment:

As we have noted before, the list of those that say QE2 is not necessary, or harmful is long distinguished and impressive. Today’s installment includes Peter Orzsag, Bill Gross and Ambrose Evans-Pritchard.

And, as we have previously noted, other than the doves at the FOMC, where is the list of distinguished heavyweights arguing for QE2? Even TARP had it local supporters like Warren Buffett.

The Federal Reserve appears to be acting without broad support, which may account for the next story below.

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•  The New York Times – PETER ORSZAG: Sailing the Wrong Way with QE2?

In other words, by perpetuating an artificially low 10-year government bond rate, the Fed may be delaying (even if very modestly, given the modest impact of the action on long rates) the very fiscal policy action that the nation most needs, while doing little to boost an economy whose principal problem is not high long-term interest rates.

•  Bloomberg.com – Fed Easing to Signify End of Bull Market, Gross Says
Bill Gross, manager of the world’s largest bond fund at Pacific Investment Management Co., said a renewal of asset purchases by the Federal Reserve will likely signify the end of the 30-year bull market in bonds. “Check writing in the trillions is not a bondholder’s friend,” Gross wrote in his monthly investment outlook posted on Newport Beach, California-based Pimco’s website today. “It is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme. It raises bond prices to create the illusion of high annual returns, but ultimately it reaches a dead end where those prices can no longer go up.” The Fed, led by Chairman Ben S. Bernanke, will announce another round of large-scale asset purchases when policy makers meet next week after deploying $1.7 trillion to pull the economy out of the financial crisis, according to a survey of the 18 primary dealers that trade debt with the central bank. Fed officials, who already cut interest rates almost to zero, are discussing more purchases of Treasuries to flood markets with cheap money as well as strategies for raising inflation expectations to prevent stagnating prices from undermining the recovery. Gross, a founder and co-chief investment officer of Pimco, said in March that bonds may have seen their best days while making an argument for investors to own fewer. He reduced holdings of government-related debt in the Total Return Fund for the third straight month in September, after the securities accounted for 63 percent of assets in June, the highest since it held an equal amount in October 2009.

•  Pimco – Bill Gross: Run Turkey, Run
Still, while next Wednesday’s announcement will carry our qualified endorsement, I must admit it may be similar to a Turkey looking forward to a Thanksgiving Day celebration. Bondholders, while immediate beneficiaries, will likely eventually be delivered on a platter to more fortunate celebrants, be they financial asset classes more adaptable to inflation such as stocks or commodities, or perhaps the average American on Main Street who might benefit from a hoped-for rise in job growth or simply a boost in nominal wages, however deceptive the illusion. Check writing [QE2] in the trillions is not a bondholder’s friend; it is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme. Public debt, actually, has always had a Ponzi-like characteristic. Granted, the U.S. has, at times, paid down its national debt, but there was always the assumption that as long as creditors could be found to roll over existing loans – and buy new ones – the game could keep going forever. Sovereign countries have always implicitly acknowledged that the existing debt would never be paid off because they would “grow” their way out of the apparent predicament, allowing future’s prosperity to continually pay for today’s finance.

•  Bloomberg.com – Mark Gilbert: Insane Fed Should Beware Unquantifiable Outcomes
Albert Einstein defined insanity as doing the same thing repeatedly and expecting different outcomes. The crazy gang at the Federal Reserve should heed those words when debating how much more market manipulation to inflict on the world of fixed income. The worrisome thing about so-called quantitative easing — a concept still novel enough to mean whatever the Humpty-Dumptys in central banking want it to — is that its consequences remain unquantifiable, and the perceived need for more central-bank purchases of securities should make investors uneasy. Fed Chairman Ben Bernanke said in an Oct. 15 speech that it’s difficult to work out the “appropriate quantity and pace of purchases and to communicate this policy response to the public.” He also said that “nonconventional policies have costs and limitations that must be taken into account in judging whether and how aggressively they should be used.” Imagine a surgeon telling her patient she wasn’t sure what size scalpel she’d be using or what the likely outcome of the procedure might be. Or an architect admitting to a planning committee that he wasn’t confident about his stress calculations or the durability of the newfangled materials he was using. “Nobody understands QE,” says Fred Goodwin, a strategist at Nomura International in London. “We have no idea how inflationary it really is. A patient juiced up on QE wants to party and it does not matter what anyone says. Don’t worry about what central banks are worried about; worry about unintended consequences.”

•  The Telegraph (UK) – Ambrose Evans-Pritchard: The Fed’s impending blunder
OK, I’ve calmed down after a week of Jamon Iberico and Rioja in Granada’s Albaycin, so I will try to be polite about the US Federal Reserve. Try, that is, not necessarily succeed. For a good insight into the thinking of the New Keynesian priesthood that rules our money and our lives, it is worth reading “QE2: How Much is Needed?” by Jan Hatzius from Goldman Sachs. His argument – crudely – is that US interest rates at zero are 7pc too high given the Taylor Rule on output gaps, et cetera (not that Professor Taylor himself happens to agree, but let us not quibble). Since rates cannot be minus 7pc, the Fed would need to launch a $4 trillion blitz of fresh bond purchases to fully compensate, such is the mess that America’s leadership has inflicted on the Great Republic. I have over-simplified: Goldman Sachs relies on a “policy gap” concept, which factors in fiscal tightening et al. This would push the Fed balance sheet to $6.3 trillion, above the $5 trillion pencilled in as the upper limit during the Great Crash. Mr Hatzius is not saying the Fed will do this, or should do this. His forecast is that the Fed will start off with baby steps of $500bn spread over six months or so, rising over time to meet the bank’s “dual mandate of low inflation and sustainable employment”.

•  The Financial Times – Dollar falls as Fed credibility questioned
The dollar lost ground on Thursday as the recent rally in the currency faltered. The dollar has performed strongly over the past week as investors have covered short positions in the currency, on speculation that the Federal Reserve would take a less aggressive approach to quantitative easing than previously anticipated in its policy meeting next week. But the dollar fell on Thursday as news that the Fed had sent out a survey asking primary Treasury dealers of their expectations of the size and impact of further asset purchases. Maurice Pomery at Strategic Alpha said the credibility of the Fed might come into question as the news suggested the central bank had no idea of how much, or how, to throw additional quantitative easing into the market. “The faith in the dollar is likely to be tested and the credibility of the Fed may be as well,” he said. “Holding US assets might just become as fashionable as kipper ties and large collared shirts.”

Category: Federal Reserve, Think Tank

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2 Responses to “More Criticism of QE2”

  1. Bob_in_MA says:

    I’m not sure how Gross, who explicitly endorses QE, can be listed as part of the opposition.

    But I think the Fed has set themselves up for future abuse. If inflation kicks up, the Fed will be blamed whether QE was actually the source or not.

    And if there’s a slowdown, they’ll probably be blamed for causing it by keeping oil/commodity prices artificially high, etc.

    It would have been a good idea to make a more convincing case to the public before launching this.

  2. Perhaps the Fed is simply trying to cap intermediate term interest rates so the Treasury can issue more debt at a low ongoing interest cost to the U.S. government ?

    There is precedent for this during WWII when the U.S. last issued mountains of debt….

    http://alaricinvestments.wordpress.com/2010/10/12/during-wwii-the-fed-successfully-targeted-10yr-rates-at-2-5/