Was QE2 effective?

Slow growth and market turmoil have brought us back to QE. Markets are expecting QE3, to be telegraphed perhaps as soon as the end of August at Jackson Hole.

It's important at this juncture to ask if QE2 has been effective. Most financial commentaters have dismissed its effectiveness out of the casual observation that the economy is still not growing very much and unemployment rate is still very high. Here is an example.

John Mauldin's latest newsletter "The Beginning of the Endgame" asks the same question about QE2:

What about QE3? Let’s look at how that last move turned out. We ended up with more money on the Fed’s balance sheet and higher commodity prices. The NFIB survey I cited last week showed there was no great demand on the part of small business for loans. 91% had what they needed. What they want are sales and customers! The trade data yesterday showed exports fell by over $2.3 billion last month. That suggests a slowing world economy. Which is borne out by numerous other indicators.

Is this a fair assessment of QE2? Would one expect QE2 to create sales and customers for small businesses such that they demand for more laons? The Federal Reserve has no such power and one should not expect anything like this to start with. A fiscal stimulus may have that effect if it's designed to create final demands for these businesses. As to trade, a weaker dollar has helped. But again, the Fed can't control the world demand for U.S. goods and services. Is a slowing world economy the failure of QE2?

This type of off-hand, sloppy remarks help to cloud the general perception of monetary policies.

St Louis Fed's assessment is a good starting point. It's mostly effective, but its effect is difficult to be disentangled with the effects from other adverse shocks such as the Japanese earthquake and the European debt crisis.

One can argue perhaps QE2 wasn't large enough.

We also hear very often that normal transmission mechanisms (e.g. multiplier effect via banking system) for monetary policy have been broken, therefore QE2 or QE3 would not be effective. Paul Krugman has a different take. There are a wealth effect and a weak-dollar effect. These two effects have important investment implications.

QE is probably not the best tool to stimulate growth when the economy is weighed down by heavy debt loads. But it's probably the only viable tool to save the economy from slipping into another recession.

Fed should maintain QE and create moderate inflation

Dow dropped another 634 points today. A lot of fear in the market. This isn't because of the S&P downgrade. Investors are panicking over slowing growth or a potential contraction. Are we heading right back to recession? What can one expect from the Federal Reserve which is having a FOMC meeting tomorrow?

Ken Rogoff expressed a clear view in this interview. He thinks that the Fed should have never stopped QE2, in fact he thinks that the Fed should make it open ended and make it clear the objective is to create inflation.

Quoting Bloomberg:

Rogoff recommended the Fed say in “very clear statements” that it’s trying to create “moderate inflation.” “In the classic classroom QE, it’s open-ended,” Rogoff said. “You say, ‘I’m trying to create inflation of, let’s say 2 or 3 percent, and I’m going to do whatever it takes.’”

The Fed should also avoid repeating that officials are trying to boost stocks, Rogoff said, calling that a “bad idea.”

The Standard & Poor’s 500 Index tumbled 6.7 percent yesterday to 1,119.46 in New York trading, its biggest decline since December 2008. The benchmark Stoxx Europe 600 Index dropped 4.1 percent yesterday in London to 228.98, its biggest retreat since March 2009.

The Fed should have extended its asset-purchase program, “as controversial as it was,” instead of ending it, Rogoff said. The central bank completed the second round of bond buying in June, purchasing $600 billion of Treasuries.

“They need to move much more decisively,” Rogoff said.

Liquidity trap and the parodox of thrift

How to interpret the economic paralysis we're in and how to think about the options we have? Here is another pretty coherent Keynesian view.



The arguments are pretty much in line with Paul Krugman's diagnosis.

QE3 maybe the only stimulant

However imperfect, Quantitative Easing round 3 may be the only option to prevent the economy slipping back into recession.

Is US making the same economic mistakes as Japan?

Difficult times call for heroic measures. But we are not seeing much of that in the government... It's difficult to sort things out. You want to read commentaries that are at least self-consistent. Paul Krugman represents such a view, in favor of the Keynesian intervention. However, that requires a heroic adminstration and a collaborative Congress which we probably don't have.

See his prognostic for the next few years.

Does market see demand destruction?

Energy has been a good performer this year. But today energy stocks of all stripes are selling off, big time. With oil hovering above $100/b, perhaps the market is seeing potential demand destruction, not only for oil, but also for other commodities?

China's surprise trade deficit adds to the heightened uncertainty. Middle East issues are not going away anytime soon, but market will probably get used to it.

We think this is an opportunity to take some risk, especially in the energy sector.

Buffett on Stocks, Bonds and Commodities

CNBC's Squawk Box team has done a long interview with Warren Buffett. This is one of the segments I like.

Two types of assets to buy: One type of asset itself will deliver a return to you; the other type will depend on what the next guy will be willing to pay for it.