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Home > Blogs > Anthony Harrington > QE2 and Gridlock in Washington – are we having fun yet?

QE2 and Gridlock in Washington – are we having fun yet?

QE2 | QE2 and Gridlock in Washington – are we having fun yet? Anthony Harrington

Investment managers contemplating the mixed messages coming from US voters in America’s mid-term elections don’t know whether to breath a sigh of relief that the resulting political gridlock is going to make it tough for Democrats to launch new major (unfunded) policies or whether to bemoan the fact that the economy is in far too fragile a position to endure political paralysis. 

To make matters still more interesting the Federal Open Market Committee (FOMC) decided that the day America woke up to a new political power shift would be a great day for announcing that the much heralded QE2 (quantitative easing, second round) was now a $600 billion reality. Hooray. Let the printing presses roll.

This is, of course, virtually the final bullet in the Fed’s gun and if it doesn’t stimulate America’s flagging economy, it is highly unclear what will. One excellent suggestion I heard recently from Mary-Anne Daly, Head of Private Wealth Management at Cazenove Capital, is that instead of buying more Treasuries with that freshly printed $600 billion, Bernanke would do far better if he bought corporate debt instead. In Daly’s words:

“The worry with the long term impact of QE is that the first time round it failed to have any lasting impact on the US economy, largely because the money was not flowing through into the real economy. If he [Bernanke] starts to buy corporate credit that would be a very different game. That frees up credit and the banks would start to lend again which would inject true liquidity into the economy.”

Daly points out that one of the major achievements of the Fed’s “loose for longer” ultra low rates policy has been to persuade the Baby Boomers to save even harder to counteract the massive hit their existing savings are taking. In an ideal world the Baby Boomers would say, “Hey, forget cash, it’s a losing asset!” and they’d shift to equities in a hunt for yield, which would be nice for the markets. Instead the statistics show them knuckling down and saving like heroes. More saving means less demand and that shifts the US economy firmly into the crawler lane.

Good as Daly’s suggestion is, it is not what the Fed intends. The FOMC statement makes it clear that its target will be long term securities. At the same time it intends to continue its August programme of buying Treasuries with the proceeds from agency debt and agency mortgage-backed securities, a sort of “soft” QE, to complement the out and out whirling of the official printing press. According to the New York Times, this would just about double the $800 billion of Treasuries the Fed currently has on its balance sheet.

Clearly the tipping point for the FOMC is the double whammy of a weak economy and weak inflation teetering perilously close to deflation. As the FMOC said in its measured way, the decision to expand the Fed’s holdings of securities in its System Open Market Account (SOMA), is designed “to promote a stronger economy and to help ensure that inflation, over time, is at levels consistent with its mandate.” This last is a curious circumlocution designed to allow the FMOC to avoid the “D” word. The Fed’s current QE programme will have completed by the second quarter of 2011, at an average anticipated purchase of about $110 billion a month, comprising the combined QE2 and debt reinvestment programme.

The much respected veteran fund manager, Bill Gross, founder of PIMCO, who oversees some $1 trillion of fixed income securities, pondered the likely impact of both the election and Bernanke’s QE2 in his latest newsletter.

Gross dismisses the election with a Shakespearian “a plague on both thy houses” shrug. “We get the politicians we deserve,” he comments. QE2 commands rather more of his attention. This time round, QE2 is “an attempted hypodermic straight to the economy’s heart” rather than the earlier “mood elevator”. If it works, the US will get 2% inflation and a significant reduction in unemployment, but, he adds, “the outcome is by no means certain”:

"We are, even as some Fed Governors now publicly admit, in a “liquidity trap” where interest rates or trillions in QE2 asset purchase may not stimulate borrowing or lending because consumer demand is just not there. Just ask Japan…”

Good point – so why just buy Treasuries, Ben? Fling it about a bit. Spice up the SOMA with handfuls of corporate debt – why not? There is no shortage of corporate paper. It’s a bonanza time for corporates big enough to tap the markets and no shortage of appetite. The Fed sitting down to share the lunch would raise eyebrows, definitely, but it would also parachute chunks of freshly minted cash into the real economy…

Further reading on QE2, the US, and global economies:

Tags: Ben Bernanke , Federal Open Market Committee , fiscal stimulus , FOMC , GDP growth , QE2 , quantitative easing , sovereign debt
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