Is QE2 About to Launch?

ZH ran a scare piece of the Fed announcing a $3T QE2 on Nov3, election day, which they argue would send the USD to the floor, gold to the roof and spawn a huge speculative fever in about everything (stocks, bonds, commodities) until it brings down the global financial system. Whoa, baby! Rein in those bearish emotions. 

Even Prechter is not this bearish. Prechter's view is the opposite, that the Fed is powerless to stop deflation, and such a dramatic move is not to be expected, or won't be tried until the very end, sparking a bout of hyperinflation .. but not now. He comments on QE here. (You may need to join Club EWI to read it, but to join is free.) He provides a longer transcript of a discussion about deflation and the Fed here. His core point: there is more debt out there that is worthless (but not yet written off) than the Fed can monetize, even with $5T of QE.

Not to be deterred, ZH ran a follow-on piece which still sees at least $1T of QE2, which would make a mockery of statements by Geithner.

Something has changed, however, ever since expectations of QE2 became consensus. The two-year bond is at record low yields, and the Dollar Index just broke below 79, falling very fast over the past week. Only 4% Dollar Bulls left, so some sort of low seems imminent. Chart courtesy ContrarianAdvisor:

Ed Harrison puts some welcome perspective on QE2 (and provides the fine picture of the boat above) when he notes that QE doesn't really affect the economy since the new money just sits in a bank vault (or reserve account) rather than be lent out. John Mauldin in Pushing on a String explains that QE has had little effect so far as the excess simply went into reserves, not new lending. He notes an analysis from a former Fed governor that says even $2T of QE2 would have a modest affect:

• lower Treasury yields by 50 bp
• increase GDP growth by 0.3% in 2011 and 0.4% in 2012
• lower unemployment rate by 0.3% at YE11 and 0.5% at YE12, still over 9%

Morgan Stanley believes much of these effects have already been priced into markets, based on recent comments by Bernanke. In any event, Mauldin does not expect the Fed to drop the QE nuclear option unless GDP comes in weaker than last quarter, currently at 1.6%. We shall learn more Thursday this week with the final Q2 revision. The Q3 estimate comes out Oct29, right before the election. Since QE2 will be good for stocks, at least at first, paradoxically a poor set of GDP reports may be bullish! Probably some speculation of how this will turn out is already baked into this rally - after all, the September-to-Remember Rally started right after the Fed's big policy offsite at the end of August.

What this sanguine analysis of QE2 leaves out is the effect on the Dollar. Ambrose Evans-Pritchard believes the Fed's real goal is to weaken the Dollar.

The US may be acting in a coordinated way all of a sudden. Besides a weaker Dollar, why not a stronger Yuan? Pressure is back on China to revalue the Yuan upwards in what some are calling Currency Wars.

A trade war is brewing; China, Japan and the US are all at odds.

Our esteemed Congress is debating a punitive tariff again, this time on a case by case basis by affected industries. Our inestimable President issued an ultimatum to the Chinese premier in the Security Council chamber at the UN on the autumnal equinox last week (Sep23), surely a poor use of the place dedicated to preventing conflict.

The last time we did something like it was against the Japanese, in 1986, who meekly complied, leading to the '87 crash, the Japanese bubble and the Japanese crash of '89. We did it then to make the US more competitive, but instead it made the Japanese companies strive to get even more efficient, and made raw materials cheaper to them than to us. We got less competitive until we finally got serious about our own corporate restructuring in the '90s. The Japanese took a 75% bath on their US debt holdings by the 4x relative rise of the Yen (from 0.25c in the '70s to 1c in the late '80s) - and a 50% loss in in one year after the US pressured them when the Yen rose from 240 to the Dollar to 120 - an absolutely huge loss of national wealth. 

This time around the Chinese hold all the cards, and are not about to let the value of all the US debt they hold be thrown away by a cheaper Dollar. The QE2 ship may be launched, but not leave any benefit in its wake, just a larger deficit and a weaker Dollar. No wonder Bernanke has been imploring Obama to fix our profligate fiscal policy to right the Ship of State. 

Comments

[Molecool]

Very nice summary - spot on.

[Michael]

We've been experiencing an unofficial weaker dollar "policy" for quite some time. Nothing really shocking about this, or what QE-II would do to the Dollar. I've been saying that the coal, iron ore, copper, and steel and commodity sectors have been the place to be for well over a year now. Unfortunately, the "Perma-Bears" who have been drinking heavily from the Prechter P3 "Kool-Aid" just don't understand this. As a result, they've missed out on some huge moves and returns.

As for ZH, when have they NOT run a "scare" piece??? Do those guys actually trade the markets, or do they simply write Gloom & Doom articles week after week, month after month, year after year?

[Mamma Boom Boom]

Eventually, people will stop talking about QE. It'll become accepted that this is what the fed does, it prints money.

(oh, the horror)

Neo-Mamma

[Wave Rust]

yelnick
Like every other american and every other country, china has learned to ignore the daily propaganda of President O'Blamer-in-chief.

we have all learned to watch what he does. china understands him much better than many americans. marxists are like that.

remember all of the soviet's new 5-year plans that came out every 3 years? each plan failed and was again blamed on capitalist pigs.

china and viet nam are more capitalistic than an Oblamer America might be.

China does not fear Oblamer or america ,,,, not even a bond collapse ,,,, their prosperity isn't totally dependent on the US.

still ,,,, don't fade the Fed and their charts. :)

wave rust

glad to see the cnbc marxist-in-chief, Zucker the sucker, leaving. Next, maybe Iranian supplier Immelt will follow.

[Wave Rust]

the usd is closing in on a low.
good scare pieces about usd crash should be followed by a cover article or two right before the election ,,,, and then the turn up for usd

stronger dollar in spite of oblamer? ya. the markets know a crash up is very close. you'll recognize it by the 20+ point opening gap that doesn't get filled. run forrest run

wave rust

[Mamma Boom Boom]

Back to the markets: is this turd going to finally break out?

Neo-Mamma

[Chuang Tzu]

Use caution, McLarens top date is for tomorrow...

http://www.mclarenreport.net.au/articles/articles/242/1/September-17-2010-CNBC-Europe-Report/Page1.html

[Michael]

"china and viet nam are more capitalistic than an Oblamer America might be." - - - Wave Rust

You have absolutely NO IDEA what you are talking about. The Chinese Government has more central state-owned enterprises than ever before and controls every single signficant piece of infrastructure be it in telecommunications, energy, transportation, or defense. Only a complete FOOL would believe that capitalism exists in China.

They are NOT innovators. They are NOT creative. They do NOT design or produce anything that is new. Their closed society and weak education system does not allow for such innovation or creativity.

To claim that Capitalism exists in China ( by any measure ) is simply ludicrous!

[Wave Rust]

michael,
suffice it to say, you dont get it.

capitalism isn't a form of government, marxism is. try looking at the difference between the two, and then the difference between econ. sys. in viet nam and china 30 years ago versus their recent history.

it's much more capitalistic than before in both. just the dramatic changes of mobilty of domestic labor and domestic capital alone is palpable and evident.

china is just emerging into a crude mercantilist base and small family businesses are everywhere.

I recognize the heavy government control but things are changing much faster than I ever expected.

I'm happy for any positive changes for a people who have been living in oppression for centuries.

Education is the door to freedom in cases like that and other underdeveloped countries. HK is also a huge change agent there just as Taiwan has always been, as it out produced per/cap the mainland for decades.

you ought to visit there and see for yourself.

wave rust

[John Mauldin]

Dave,

John Mauldin here. Like your stuff. Would love to chat. How does one get in contact with you?

John