This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

QE2: Likely Impotent

NEW YORK (TheStreet) -- After more than a month of expectation, QE2 time has finally arrived. Both debt and equity markets have been excited in anticipation despite the fact that no one really knows, including, it seems, the Fed itself, what the Fed intends to accomplish by bloating up its already pregnant balance sheet. There are likely to be serious unintended consequences.

Liquidity Trap

QE2 faces an economy in a liquidity trap. Monetary theory has always focused on the "M" in the MV=GDP equation, postulating that growth in "M" will impact GDP if "V", the velocity of money, stays constant. But, in a liquidity trap, an increase in "M" is offset by an equal decrease in "V" resulting in no new economic activity. The U.S. economy has observed a rapid decline in "V" over the past two years as the Fed has bloated its balance sheet. Excess reserves at banks have exploded while loans outstanding have continued to decline.

Thus, the Fed cannot be hoping that QE2 will spur loan growth. Given historic lows in interest rates, they can't be foolish enough to think that lowering them by a few more basis points will have more than a marginal impact. So, what can they possibly be thinking? The following comes to mind:

  • The "wealth effect"
  • Raised inflation expectations
  • A weaker dollar
  • The Wealth Effect

    Over the last month, the announcement of QE2 successfully inflated equity prices. If QE2, the reality, doesn't disappoint, the "wealth effect" of rising equity values may cause rising consumer confidence and more consumer spending. Of course, that is a big "if." Even assuming that QE2, the reality, doesn't disappoint, studies of the "wealth effect" suggest that its impact is small compared to other policy tools. Thus, the size of QE2 would have to be gigantic to have a significant impact. The latest scuttlebutt from inside the Fed indicates that QE2 will not be "shock and awe." Thus, the impact of the "wealth effect" is likely quite small.

    Inflation Expectations

    Rising inflation expectations actually either raises interest rates and/or weakens the dollar relative to the currencies of its trading partners. Bill Gross of PIMCO recently postulated that QE2 will spell the end of the 30-year bull market in bonds precisely because increasing inflation expectations will add an inflation premium to bond yields across the yield curve. In a market struggling with a lack of demand, rising rates via inflation expectations, would be a negative unintended consequence. (Note: When interest rates are at or near zero, except for an anomaly or two of negative yields as witnessed with the Treasury Inflation Protected Securities (TIPS) auction, there is really only one way for rates to go, and eventually, they will go up. The only question for bond managers is "when".)

    Weaker Dollar

    The announcement of QE2 caused a near run against the dollar in the currency markets. Today's conventional wisdom says that a weaker dollar will cure the trade deficit and bring jobs back to the U.S. Unfortunately, it is foolish to believe that any improvement in the trade deficit caused by a weaker dollar will have any sort of immediate impact on U.S. jobs.

    1 of 2

    Select the service that is right for you!

    COMPARE ALL SERVICES
    Action Alerts PLUS
    Try it NOW

    Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

    Product Features:
    • $2.5+ million portfolio
    • Large-cap and dividend focus
    • Intraday trade alerts from Cramer
    • Weekly roundups
    TheStreet Quant Ratings
    Try it NOW
    Only $49.95/yr

    Access the tool that DOMINATES the Russell 2000 and the S&P 500.

    Product Features:
    • Buy, hold, or sell recommendations for over 4,300 stocks
    • Unlimited research reports on your favorite stocks
    • A custom stock screener
    • Upgrade/downgrade alerts
    Stocks Under $10
    Try it NOW

    David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

    Product Features:
    • Model portfolio
    • Stocks trading below $10
    • Intraday trade alerts
    • Weekly roundups
    Dividend Stock Advisor
    Try it NOW

    Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

    Product Features:
    • Diversified model portfolio of dividend stocks
    • Alerts when market news affect the portfolio
    • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
    Real Money Pro
    Try it NOW

    All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

    Product Features:
    • Real Money + Doug Kass Plus 15 more Wall Street Pros
    • Intraday commentary & news
    • Ultra-actionable trading ideas
    Options Profits
    Try it NOW

    Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

    Product Features:
    • 100+ monthly options trading ideas
    • Actionable options commentary & news
    • Real-time trading community
    • Options TV
    To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
    Submit an article to us!
    DOW 16,979.13 +59.54 0.35%
    S&P 500 1,986.51 +4.91 0.25%
    NASDAQ 4,526.4820 -1.0320 -0.02%

    Brokerage Partners

    Rates from Bankrate.com

    • Mortgage
    • Credit Cards
    • Auto

    Free Newsletters from TheStreet

    My Subscriptions:

    After the Bell

    Before the Bell

    Booyah! Newsletter

    Midday Bell

    TheStreet Top 10 Stories

    Winners & Losers

    Register for Newsletters
    Top Rated Stocks Top Rated Funds Top Rated ETFs