QE2: Impact at Home and Abroad

The Fed has saved the day….and the stock market….shoving up the S&P500 by 3.6% last week.  Not only did the Fed deliver on the highly expected quantitative easing, but Ben Bernanke came out of the closet and admitted–in a Washington Post Op-Ed–that one of the Fed’s goals is to boost stock prices.  The VIX fell, but interestingly not back down to the lows last seen in April before the Greek sovereign debt crisis exploded. 

And now, everyone’s jumping into the risk pool, buying everything in sight.  The last time this happened was immediately after the credit crunch materialized in August 2007.  The Fed leaped into action, slashing rates and the stock market soared to new highs in late October of that year.  Then reality set in, but later in 2008. 

The economic data, as if they matter anymore, continue to paint a picture of a struggling economy.  Personal income and spending both sorely disappointed.  ISM manufacturing came in better than expected; ISM services met expectations.  Initial jobless claims were much worse than expected, at 457,000.  Pending home sales fell; they were expected to rise.  Non-farm payrolls were, at first glance, better than expected, at 151,000.  But the birth/death model magically conjured up 61,000.   The unemployment rate rose slightly from 9.58% to 9.64%, and the broader measure (U-6) remained at an elevated 17.0%.  Beneath the surface, other data pointed to problems with employment.  The household survey reported that 330,000 jobs were LOST in October.  The labor force participation rate and the employment population ratio both fell to near cycle lows; if employment was genuinely improving, both of these figures would be rising.  And the number of folks unemployed for more than 26 weeks also rose to 6.21 million, up from 6.12 million in September.

The impact of QE at home and abroad could turn out to be very damaging.  This impact would show up in the numbers later, perhaps early 2011.  But show up, it will.

At home, Karl Denninger, explains in simple terms how Mr. Bernanke’s money printing will backfire, resulting in a “downward-spiraling economic disaster”.

Mr. Denninger describes QE as a hidden tax on consumers and businesses.  By debasing the dollar, major globally priced inputs (mainly oil, raw materials and food) will soar in price.  This is already happening.   Higher food and energy costs result in lower disposable income for consumers, AND lower hiring and wage increases for businesses (who’ll cut labor costs to offset the higher material and energy costs).  In turn, this will lead to higher costs for government social programs, because poorer consumers will turn to the government for more benefits–unemployment, food stamps, Medicaid, etc.  But with lower income tax revenues from the poorer and fewer wage earners, the government will need to borrow more from the bond markets.  And since the bond markets will not lend to the government at today’s paltry interest rates, the Fed will be forced to do “even more QE to ‘spur employment and increase asset prices'”.

Voila, the Fed is trapped.  It created this death spiral.  It has sucked the US government and economy into it, and there is no way out….without a lot of damage and pain.

Abroad, the reactions are pouring in, and they’re all nasty.  China’s central bankers have attacked QE and currency manipulation and utter hypocrisy by the US which has been attacking China for manipulating IT’S currency.   Xia Bin, a long-standing adviser to China’s Central Bank, called the blatant printing of dollars as “the biggest risk” to the global economy.  “As long as the world exercises no restraint in issuing dollars then the occurrence of another crisis is inevitable, as some wise Westerners have lamented”.

Germany’s finance minister,  Wolfgang Schäuble, lashed out by saying so “With all due respect, US policy is clueless”.

Guido Mantega, Brazil’s highly respected finance minister, attacked QE by remarking that “it does no good at all to just throw dollars from a helicopter.”

What’s next?  At first, inflation in daily goods and services, food shortages, and spiking energy costs.  Then currency wars could easily escalate to trade wars, as these angry economic powers say “no mas” to the Fed and the Treasury.  Sadly, the ultimate outcome, as populations around the world begin to riot, will probably be a hot war, or two.

We’ve seen this movie before.  It was filmed in the 1930’s.

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