This Day On The Street
Continue to site
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

Why QE2 Won't -- and Can't -- Work

NEW YORK ( TheStreet) -- QE2, to put it simply, does not address the fundamental problems the U.S. economy faces. It is preposterous to think that reducing medium-term interest rates by 25 to 50 basis points is going to lead to a significant increase in gross domestic product and a reduction in unemployment.

The package

After much anticipation, the Federal Reserve unveiled a second round of quantitative easing (QE2), or bond buying, two days ago. It wasn't a surprise. Market participants had expected $500 billion to $700 billion of bond purchases, and the Fed announced $600 billion. The purchases will happen on a regular basis through June 2011.

It works in the following way: The Fed will be in the market buying Treasury bonds mainly in the 5- to 10-year range. The $600 billion size means the Fed will be effectively buying most of the newly issued Treasury debt in this maturity range. This is in addition to the purchases being made with the income and maturing bonds from the first round of QE. That increases the amount of buying to about $800 billion.

The Treasury needs to issue debt to finance the sprawling fiscal deficit. The Fed buys the debt. It is added to the balance sheet as both an asset and a liability. In the end, the Fed's balance sheet will grow to a staggering $3 trillion, which is 20% of GDP. That puts the U.S. in an exclusive club -- second only to the 23% held by a country with a disastrous monetary-policy record: Japan.

The logic

Fed buying will increase the price of the bonds. Increased prices will reduce interest rates. There will be an indirect effect on other securities, such as corporate bonds and mortgage-backed bonds. Given that the Fed is buying such a large proportion of new issues, it is hoped that other fixed-income investors will shift some of their demand to mortgages and corporate bonds. This will increase prices and reduce interest rates. This will make corporate financing cheaper and presumably drive down the mortgage rate.

There is a secondary effect. As U.S. interest rates go down, the U.S. is presumably less attractive for foreign fixed-income investors. This may put downward pressure on the exchange rate. A cheaper exchange rate means exports are more competitive and imports are more expensive.
1 of 5

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

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
Stocks Under $10

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

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

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
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
AAPL $110.78 0.00%
FB $94.01 0.00%
GOOG $641.47 0.00%
TSLA $241.50 -1.90%
YHOO $30.85 0.00%


Chart of I:DJI
DOW 16,776.43 +304.06 1.85%
S&P 500 1,987.05 +35.69 1.83%
NASDAQ 4,781.2640 +73.4890 1.56%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs