All aboard the QE2 – double or quits | FT Alphaville

All aboard the QE2 – double or quits

To sail upon the great world cruise of QE2, or not? – that is the Fed’s question.

One thing that is sure, the FOMC’s policy statement on Tuesday opened the door to the option of more quantitative easing in the near future.

The key amendment in the statement being:

The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.

And so far,  consensus seems focused on three implications in particualr:

1) the fact that the global devaluation race has just stepped up a notch. (the $USD index has hit a six month low this morning).

2) that gold may sizzle once more. (the precious metal is at a  fresh nominal high this morning).

3) and that inflation fears could once again be revisited, especially as the dollar devalues.

Os as RBS succinctly puts it:

In the race to the bottom (in the game of currency devaluation) the US continues to pull ahead. Japan fought back valiantly with its unsterilized intervention a week ago and has made up ground against the European currencies. Eurozone has lost ground for the time being as EUR rallies by default. With all the major currencies looking shaky, gold is hitting new highs.

The bank’s Global Views note, meanwhile, highlighted the impact of the Fed changing its focus from the economy and to any possible prospect of deflation:

The shift in focus from the economy to inflation solves a lot of problems for Bernanke. (1) Providing more accommodation to offset disinflation carries a much lower risk of undermining confidence than taking action because the economy is weak. (2) The whole debate over how weak the economy had to get to justify action — did it have to deteriorate or simply fail to improve? — is now irrelevant. There is no need for Bernanke to forge a consensus on this front.

By comparison, it should not be hard to forge a consensus on action to prevent deflation. With inflation showing no sign of an upturn, hawks can’t disagree with undertaking QE II to get prices moving back toward the Fed mandate.

(3) It makes clear why quantitative easing is being undertaken and what the goal is. The point of QE II is not necessarily to bring down interest rates and boost the economy (a scenario that most, including many members of the FOMC, are sceptical of). Rather, the Fed is engaging in QE II to reduce the risk of deflation (though the threat itself may be small, the consequences of falling behind the deflation curve would be devastating). In any case, while the current risk of deflation may be debated, few would disagree that QE is the correct approach if the Fed sees that problem.

Erste’s Bank’s Rainer Singer followed a similar note, calling the Fed’s expressed discontent with the current level of inflation a decisive new message in Tuesday’s release:

Obviously, the discontent was not strong enough to trigger any new measures yet, such as renewed purchases of securities. The Fed rather seems to want to look at further incoming data or possibly just wanted to prepare markets for a new round of quantitative easing ahead.

Inflation indicators will get a lot more attention from markets in the future and the Fed has substantially opened the door for more quantitative easing. As the data until the next FOMC meeting at the beginning of November is unlikely to ease the concerns of the FOMC members, renewed quantitative easing is very likely to be announced then, in our view.

FX markets considered the risks of more monetary expansion and the dollar lost ground and Treasury yields declined.

But it’s Marc Ostwald at Monument Securities who has once again hit the commentary out of the park.

Clearly unconvinced, he warned on Tuesday (our emphasis):

Given that the contrasts between this statement and that of August rest primarily (though implicitly) on a downgrade of the FOMC’s (core) inflation forecasts, the FOMC his treading the route of making a rather large policy error, and one that is typical of a situation in which previously enacted measures have failed to achieve a desired result, but are then doubled up to try and force a favourable result.

The best of his comments being ( favourites highlighted below):

In principle it will require an unlikely and quite sharp improvement in incoming data to prompt a rethink at the Fed. While the Fed can do little to influence prices of non-discretionary goods where demand from the developing world is now the critical factor.

The lack of any acknowledgement (in the statement) about rising food, cotton and other commodity prices, one can only presume is down to a belief that this is a passing trend, or rather an intended omission given that it would offer a major hurdle to further QE.

Of course if and when there is more QE, this will likely drive the prices of such commodities (as well as other risk assets) ever higher, the USD ever lower, thus achieving a level of inflation which, while not necessarily initially alarming, is not consistent with their mandate.

As for what more QE might achieve, I would repeat the observations from yesterday’s preview: “I would suggest that the chasm between the real and financial economies is getting ever larger, and that while QE has undoubtedly help to keep longer-dated interest rates down, this has been of little or no benefit to the economy (jobs, consumer spending, orders and/or exports.

In some respects, what is missing from the QE apologists’ rationale is an understanding that (i) it is the mountain of debt in the govt, financial, consumer and housing sector and not the cost of servicing it that is the issue, (ii) it is also the original mismatch in the term of assets and liabilities in the financial sector, which in effect ensures that QE is being funnelled into a ‘liquidity trap’ and this in fact tends to prompt more volatility once the flow of (new) QE has stopped (i.e. sharp turns in risk on/risk off), and as such one could term QE ‘casino table money/chips’.

As such it is arguable that the pro-QE2 argument is little more than very myopic self-interest, which fails to properly consider the ‘law of diminishing returns’ or ‘law of unintended consequences’ aspects.

Of course none of this means that there will not be more QE at an FOMC meeting later in the year, but we hope that it offers some food for thought.” The old adage that “money has no intrinsic value, it merely represents value” is clearly one that the FOMC (ex-Hoenig in terms of current voters) wishes to replace with “money does not even represent value, it’s just an illusion”.

As such one is reminded of the words of Art & Cultural Historian Jacob Burckhardt: “The state incurs debts for politics, war, and other higher causes and ‘progress’. . . . The assumption is that the future will honour this relationship in perpetuity. The state has learned from the merchants and industrialists how to exploit credit; it defies the nation ever to let it go into bankruptcy. Alongside all swindlers the state now stands there as swindler-in-chief.” (Judgments on History and Historians (tr. Boston: 1958), p. 171 – cited in Super Imperialism by M. Hudson)

So no holding back there for Marc.

And for those interested, this is what casino money chips look like aboard the QE2:

(And all because we couldn’t find a picture of the QE2 in De Nile.)

Related links:
El Erian: The Fed, as expected…
– FT Alphaville
FOMC follow-up
– FT Alphaville
Fed clears decks for further easing – FT