QE3: Why Not?

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK (TheStreet) -- The recent string of U.S. economic data has been simply dreadful. Estimates for growth are being revised down. The Federal Reserve's purchases of Treasuries, under what has been dubbed QE2, are coming to an end in a few weeks. The discord that is preventing raising the debt ceiling reflects disagreements over the pace of fiscal consolidation. It is not clear what kind of policy response to further economic weakness can be delivered.

The rating agencies' recent warnings and the political considerations suggest that the scope for a fiscal response is minimal at best. Instead of talking about a new fiscal compromise, like the unexpected one for this year, talk of a monetary response, QE3, has begun. To help further the discussion, let's consider three aspects here: efficacy, probability of QE3, and other potential actions.

Efficacy

To evaluate whether the Fed's purchases of Treasuries has been successful, we have to appreciate what it was trying to achieve. Most important to note is that the Fed itself does not call these operations quantitative easing. The market does. Do not confuse the market's short hand with the facts. The Fed calls what it is doing Long-Term Asset Purchases. Its explicit goal, then, is not targeting its balance sheet -- like the Bank of Japan. It was not to boost money supply nor was it was too increase bank credit. Altogether, there are many other things the Fed's Treasury purchases have failed to accomplish. Many observers cite these and conclude QE2 has not been successful.

The problem may lie more with the metric than QE2. Federal Reserve Chairman Bernanke addressed the issue head on at his first regular press conference following the April FOMC meeting: "The conclusion that the second round was ineffective could be validated only if some thought this was a panacea. Relative to what we expected, and anticipated, the program was successful."

In recent comments, Bernanke has referred to the stock market's rise as part of the evidence that the Fed's bond purchases have been effective in boosting the demand for riskier assets, as it removes risk free assets from the market. Through early June, the S&P 500 is indeed out performing all other G7 bourses, the BRICs and most of Asia. To be sure it is not so much that U.S. equities are posting a sharp advance. In fact, the gain thus far this year of 3.4% is, if anything lagging behind its long-run historic pace.