Monetary Game of Chicken: The Fed Will Win

NEW YORK ( TheStreet) -- I continue being baffled by the supposed expectation of QE3 since a few weeks ago.

Credit Suisse, by way of FT Alphaville, offers the most sensible explanation of what has been driving the recent episode of irrational exuberance, especially since the most recent better-than-expected employment and housing data: international money escaping from disaster areas (presumably China, Japan, much of Europe, and possibly everywhere else except Canada and Australia -- presumed by me, not Credit Suisse). As domestic individual money wakes up and withdraws, it's comforting to know that international dumb money can be counted on.

It is indeed a strange world we are living in. The U.S. can most afford inflation risk, especially commodity inflation, which is the most likely consequence of monetary over-easing as demonstrated in the aftermath of QE2. This is due to several factors:
  1. U.S. dollar is still by far the most prominent reserve currency, thus can export inflation to the rest of the world like no other. I know, it won't last forever, but tomorrow is another day.
  2. U.S. is a big agricultural exporter.
  3. U.S. dependence on foreign oil is greatly exaggerated for cheap political reasons. U.S. has ample domestic oil production, easy access to vast foreign sources, and is destined to be the biggest natural gas producer for a long time to come.

Yet the Fed sees no need to ease as inflation expectation staying in the comfort zone and economy is all in all quite resilient and stable. As to unemployment, first of all I simply don't understand why it's central bank's business and, secondly, I suspect the Fed knows quite well the absurdity of this mandate and that there is nothing it can do here.

On the other hand, the eurozone could use some serious easing. It should be targeted to specific countries and regions; unfortunately the politics has caused a complete paralysis so far. In fact, I find it amazing that the market still gives any credence to what European Central Bank head, Mario Draghi, says.

I don't know where the pain threshold for meaningful action is; but it's clearly not yet been reached. Hopefully it won't be reached until the world has all but written off the euro and prepared for the day after. So here's to the eurozone paralysis.

China still enjoys nominal growth rates that are the envy for the rest of the world. But the real growth is far from certain, especially considering the massive M2 expansion since '08 (official number is 4 trillion CNY, or about $700 billion; real number who knows but it's safe to assume it's bigger).

Regardless, as everything else in the world, what matters is the margin. If growth rates drop, it's bad regardless of the absolute value. And China is definitely slowing down. On the other hand, China is very vulnerable to inflation, especially commodity inflation, both economically and socio-politically.

China is perhaps in the most difficult monetary position at this point: it is in dire need of easing, or at least according to the natural instincts of politicians, yet it can least afford doing so (with the possible exception of India, which seems to be in a worse shape in terms of real growth). This is arguably the biggest test of Chinese leadership and the greater society since at least the 1989 Tiananmen massacre.

Japan, of course, will continue threatening to ease and intervene in the FX market, making baby steps and having little effect. This is actually not cynicism. Nothing has changed enough, as far as Japan is concerned, over the past 20 years to warrant any change of action plan.

Granted, the macroeconomic environment has never been nearly has bad over Japan's lost decades; in fact, Japan probably would have fared much worse if its baby boomer retirement era had been in sync with the west.

However, it's doubtful there's anything Japan's central bank, the Japanese government, or even the entire Japan, Inc. can do to help the situation currently. There's really nothing anybody can do in the face of such a huge, widespread demographic wave, which I've maintained since 2009 as being the root cause of the ongoing crisis era.

Of all the big central banks, whoever eases first will bear the most risk of potential inflation, while others in the global village would get some benefits of eased pressure. Though I doubt it's conscious, the big central banks are in a game of "who can take the pain the longest."

Please, for crying out loud, stop whining for QE3. It's probably not happening in Europe, either. China may do it, but it's not clear at all that would be a good thing for anybody.

But the market has been a hopeless alcoholic on liquidity (been to Manhattan's After Market Liquidity parties anyone?) for many years now. So it will continue hoping for more.

It's dangerous to short the risk-on rally, though, since we are caught in a catch-22 limbo land: if the economy goes bad, Fed easing would prop up the market, or at least so it's hoped; if the economy goes OK, QE3 is not coming so the market may not rally much at all.

Here lies the biggest joke central banks of the world have created, on themselves: by selling their souls to politicians, they have doomed the market to limbo land and ultimately hurt their masters.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.