QE2 Will Fail

Earlier this week, the Fed announced that it decided to expand its quantitative easing program by 600 billion USD.

The program hopes to keep the U.S. economy on track to recovery and strengthen the pace of growth.

Blah, blah, blah, blah…

I talked about the details of the announcement in my post last Thursday, so I won’t be going into this anymore.

Now let’s get into the meat of this article: Why QE2 will fail.

QE2 Came in Too Late

When the economy was showing signs of possibly heading into recession again, the Fed took a “wait-and-see” approach. In fact, the Fed even talked about “exit strategies” to remove the billions… err, TRILLIONS of dollars it had injected into the economy.

One thing you should know about shifting monetary policy stances is that it takes time to see the effects. If you remember, the Fed’s first quantitative easing move was done in March, but its effects were only felt in December.

I hate to say this, but the Fed was a bit behind the curve on this one. It used GDP, inflation, and high unemployment rates, all of which are lagging indicators, as reasons behind its move.

Instead of using lagging reports, the bank should’ve relied on forward-looking indicators. I’m sure the Fed’s army of economists is more than capable of making sound economic forecasts, right? As the old adage goes, prevention is always better than cure!

Confidence is just way too low

One of the reasons why FOMC hawks pushed for further stimulus is to lower borrowing rates in hopes that QE2 will spur spending. Call me a pessimist but I don’t really see this as a “Eureka!” moment for the Fed.

Reports from bank lending officers show a weak demand for loans despite having near-zero interest rates in place.

Perhaps the reason why consumers aren’t struttin’ their wallets isn’t that borrowing is expensive.

Maybe it’s simply because they lack the confidence to spend. Studies have shown that consumers have been sitting on their cash and that businesses have been keeping their money locked up as well.

If I am right and people feel insecure about their own balance sheets, then cheap credit would do very little to help the economy.

QE2 hurts global trade

It’s equally important to see how the Fed’s move plays out in the international arena.

Another point raised by the pro-QE2 gang is the positive effect of a weak dollar on exports. Sure, we’ll probably see an uptick in the country’s trade balance with American exports being relatively cheaper compared to those of other nations. But economics teaches us that there’s almost always a trade-off.

When the U.S. prints new bills, it, in effect, showers the global economy with extra liquidity. Herein lies the rub.

The rest of the world doesn’t need this extra liquidity right now. Brazil and China, along with other emerging economies, already have their pedals to the floor. It may not take much to derail these economies from their recoveries.

You may have noticed the term “currency wars” has been thrown around a lot lately, and for good reason–no one wants a strong currency. But that’s exactly what the Fed is giving other countries.

As the dollar depreciates, it puts upward pressure on other currencies, threatening to harm their export industries. And at the moment, two of the largest economies, the eurozone, and Japan, don’t look like they’re in a position to tolerate further appreciation of the euro and yen.

QE2 devalues U.S. debt

Over the years, the mighty dollar has become the world’s reserve currency. This status has allowed the U.S. to borrow from foreign lenders at favorable rates.

The problem is, printing new money results in the depreciation of the dollar, which devalues the U.S.’s dollar-denominated debt.

Obviously, this doesn’t sit well with the U.S.’s lenders and makes them more inclined to think twice about lending the U.S. money in the future. Why would anyone want to lend money knowing they’ll be paid back at a lower value in the future?

As you can see, not only does the U.S. risk stalling its own economy, but it puts the global recovery on the line as well.

QE2 is not enough

Now, I will say what many have thought, and even more, have feared: QE2 is not enough. But really, what else can the Fed do? There is no quick fix to its economic predicament.

Inflation will likely stay subdued and below target, unemployment will probably stay stubbornly high, and spending will probably remain weak. Sometimes, there’s really not much you can do but to bite the bullet and let the economy run its course.