Tuesday, November 23, 2010

What's the Deal with QE?

It would appear that the air is heavy with negative sentiments about the Federal Reserve's second round of quantitative easing, or QE2, as it is affectionately nicknamed. Congress likes to get hot-headed about economics (especially economics they don't understand), however now it seems they've gone past merely hot, all the way to boiling. There have been the occasional, acrid remarks about dissolving the Fed's independence, and there have been slightly less extreme accusations that the Fed's double mandate has failed. That mandate dictates that the Fed must strive for full employment and price stability. Of course, there is also the, now infamous, Youtube video of the fuzzy animals hashing out the details of QE. I'm not going to get into any of these attacks, or their validity, but I am going to give a few reasons why QE may not be the greatest invention since sliced bread.

Firstly, let's look at the markets. No, the stock market does not perfectly describe the state of the economy, but it is usually a fairly good barometer of how people FEEL about the economy, justifiably or not. FAS, a financials ETF, peaked on November 4 at $26.81. Since then it has tumbled around 20%. The S&P 500 went from a November 4 peak of 1226.26 down to 1180 today. Market jitters galore. When people are already worried about the effects of QE, we'll probably end up, as usual, with a self-fulfilling prophecy.

Secondly, QE is, quite simply, untested. This is, obviously, the second time it has been used, and there is not enough literature on the subject to really understand the effects. In classical lore, printing money (which is in essence what the Fed is doing to buy up long-term assets), is associated with rampant inflation. Of course, inflation is around 0.9% right now, so maybe we SHOULD hope for that number to rise. But then again, maybe it won't. Maybe it'll rise TOO much. We just don't know.

The last point I want to make is that other countries (notably emerging markets) are unhappy with us. The story's a bit complicated, so I'll simplify. The Fed, and U.S. government, have criticized China for artificially devaluing the renminbi. Fair claim, this is true. The emerging economies (and others, for that matter) look at the U.S. and say, "Hey, well, QE effectively works as currency manipulation, too. Don't be hypocrites America! You're (now weakened) dollar is hurting our exports!." This is, also, a fair argument. China, now, turns to us and says, "We hold a great deal of your debt. When you manipulate your currency like this, the value of our holdings declines, so stop it!" The Fed does not intend to play with the value of the dollar, but QE does change that value. Nobody's wrong in the arguments above, which, I suppose, is the real issue.

I won't come all out and completely lambast the Fed for QE. Economic policy takes time. Maybe the beginning is the rough part. So far though, I can't say I'm all too pleased.


  1. Nice post!

    A few thoughts: I don't think the decline in the stock market is necessarily reflective of opinions about QE2 - I believe the "market jitters" mostly stem from the euro-crisis and concerns about Ireland and beyond. But even if you do want to look at the stock market, I don't think it's fair to pick a 3x leveraged ETF (without even mentioning the leverage) whose performance is only designed to track daily returns.

    Also, I'd take your point about how "maybe we should" be hoping for inflation a step farther to say that we definitely should. It's the only way I see to encourage spending. I think the Fed should be doing all it can to create inflation - something that is admittedly hard to justify given its mandate of price stability...

    Finally, what the US is doing is monetary policy with exchange rate side effects. What the Chinese are doing is blatant currency manipulation. I think there's a big difference.

  2. 1. Fair enough. That's a fair criticism, but while it's hard to pinpoint exactly why the market reacts the way it does (in fact, it's impossible), it can't just be pure coincidence that the drop in the market lines up, date-wise, almost exactly with QE2.

    2. I agree with you... I was just using coy language.

    3. I never said (say) that China is doing the same thing as the U.S., but they claim that we are, and that we just don't openly admit it. There is no way, I think, the U.S. would purposefully manipulate its currency, but regardless, finger-pointing abounds, and we still look like hypocrites.