Fed Scorecard: Five Ways QE2 Worked—And Where It Failed
Quantitative easing—which ends Thursday—effectively reached some of its goals and badly missed at others, but the unprecedented government intervention program’s final legacy is far from being written.
Fed Chairman Ben Bernanke launched the program with hopes that it would create a “wealth effect”—a rise in asset prices that would help convince Americans that the financial crisis had passed and better days were ahead.
No doubt there has been a considerable rise in a variety of assets, and if you’re lucky enough to own them you probably did quite well in the eight months since the central bank launched the second wave of easing, known as QE2 in market lingo.
But if you were one of those stuck in the mud of the housing market downturn and jobs slump, you didn’t do nearly as well.
A look, then, at five areas where QE2 worked—and five were it failed.
WHERE IT WORKED
1) The Stock Market Soared. Yes, there’s that. Major indices last summer had fallen 17 percent from their April 2010 cycle highs and it looked like there was little relief in sight. But after Bernanke’s Jackson Hole speech in late August and subsequent official QE2 launch on Nov. 12, it was a different story. The Nasdaq jumped 29 percent, the S&P 500 rose 25 percent and the Dow industrials surged 23 percent. So if you are part of the 20 percent of the people who own most of the stocks, you saw a wealth effect indeed.
2) Commodities Climbed. Certain commodities, like oil , copper and, for a while, silver , saw moves that could only be described as parabolic. The connection to QE2 was undeniable: All that money-printing debased the dollar, in which commodities are valued. So cheap dollars equate to strong commodities, simple as that. The CRB index rose 11 percent while the dollar fell 10 percent during QE2. That’s a pretty straight line.
3) A Boost for Exports: See previous item: Cheap dollars make for cheap exports, and commodity-driven stocks led the market rally. Energy rose 45 percent while materials surged 31 percent. Multinationals prospered and set the stage for a move to big-cap stocks in 2011 and beyond.
4) Prevented Japan: More specifically, QE2 put a halt to fears that the US was heading towards Japanese-style deflation. By pumping enough liquidity into the markets, and doing so sooner rather than later (i.e. Japan to its 1990s recession) Bernanke was determined to avoid a “lost decade.” Of course, this approach had its consequences, which we’ll discuss shortly.
5) Created ‘Wealth Effect’ for the Wealthy: In summary, if you had the resources to run the short-dollar/long commodities/long stocks trade, and had the dexterity to get in and out at the right times, you had one whale of a wealth effect.
WHERE IT FAILED
1) Housing is Broken. In a CNBC Interview Thursday, Tobias Levkovich, chief market strategist at Citigroup , insisted that "QE2 was never designed to drive the housing market." Wrong. In an op-ed piece in the Washington Post just before the QE2 launch, Bernanke was clear about his goals: “Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance.” But the housing market is now in worse shape than the Great Depression, and even the rosiest projections are for a flattening and finding some bottom in pricing. So all that rate-cutting, dollar-cheapening and market manipulation still hasn’t cured real estate.
2) The Jobs Market is Broken, Too. Yeah, and there’s that. QE2 liquidity was supposed to “spur spending,” “lead to higher incomes” and create a “virtuous cycle” that would “support economic expansion,” according to the Bernanke WaPo piece. Um, no, no, no and no. Companies have hoarded cash, income has lost traction to inflation, and GDP is 1.9 percent while unemployment is stuck at 9.1 percent—lower than when QE2 started but actually trending higher.
3) Inflation May Not Be “Transitory.” Bernanke repeatedly has called food and energy price pressures from inflation “transitory” and likely to reverse. He has been somewhat right on the energy call, but food prices are moving consistently and in some cases dramatically higher, while other areas of the economy are catching up as well. Inflation is trending at 3.6 percent now, and that doesn’t include what is expected to be a coming surge in rents, which make up 40 percent of the Consumer Price Index. Inflation as QE2’s enduring legacy is Bernanke’s biggest nightmare.
4) Dollar Destruction: See commodity price and inflation entries above. The dollar index, which measures the greenback against a basket of foreign currencies, has moved in an almost perfectly inverse fashion with commodity prices, which in turn are driving inflation. Here’s where it gets really scary: The Fed has almost no wiggle room to raise interest rates considering how much debt is weighing down the government’s balance sheet. But if inflation keeps building, so will pressures to raise rates and support the dollar . In that case, Bernanke will find himself in a brutal no-win situation.
5) Interest Rates Are Actually Higher: A real wild card whose significance also is yet to be known. Rates are still low—unnaturally low, some might say. The $600 billion worth of Treasury buying plus another $80 billion or so in Permanent Open Market Operations drove prices lower and rates higher. The yield on the 10-year Treasury note actually has risen from the 2.76 percent level when QE2 started and the 2.66 percent at the time of Bernanke’s Jackson Hole speech. If the stock market rally keeps going and investors continue to ditch Treasurys, interest rates could spike and create even more problems for the debt-laden government.
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