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QE2 – an unmitigated disaster?
This post is a guest contribution by Dian Chu, market analyst, trader and author of the EconForecast blog. There was a debate recently between Rick Santelli of CNBC and James Bullard, President of the Federal Reserve Bank of St. Louis regarding the inflation effects of the QE2 initiative. Bullard, the economist, cited the core inflation rate, and even the headline inflation rate as illustrative of a lack of serious inflation pressures in the US economy. Santelli, on the other hand, talked the trader`s perspective of inflation wanting to use the CRB Index (Fig. 1) as a true indication of inflation effects since QE2 was brought up at Bernanke’s Jackson Hole Speech in August 2010. So let us compare two scenarios and ask ourselves would the US economy be doing better without the QE2 initiative? Pre-QE2 Prices:
QE2 Effects So Far:
About That Unemployment Rate… Nevertheless, I must add that the unemployment rate is better, and we have created more jobs since QE2 but with a highly fluctuating job pool where workers give up looking and leave the labor market it is hard to gauge the real unemployment numbers. Plus how much of the job creation is due to other factors like more business friendly policies from the Obama administration, a Republican Landslide in the Midterm Election, and the extension of the Bush Tax Cuts and a reduction in the payroll taxes for businesses? Equity Gains Don’t Mean Much Clear Present Danger – Inflation More importantly, inflation data utilized by the core and headline rates are behind the curve of futures prices by anywhere from 3-6 months so the true inflation pass through effects of these higher input prices at the futures level have yet to be realized in the Fed`s measures of inflation data. For example, gasoline prices at the pump probably lag the futures prices established by the RBOB contract by 20-30 cents. Likewise, the full effects of higher cotton prices will take much longer to work their way through the supply chain to consumers at the retail level for clothes they purchase. It may take another six months for the damage that has already occurred at the futures level to be fully experienced by consumers of cotton products, which would lead to an underestimate of the current inflationary effects in the economy. Biflation at Work And if you add in the 6 month lag factor for inflation effects to pass through to the data, a completely different inflation story starts to emerge. Wanted – Lower Inflation & Interest Rate This assumes that some inflation is better than no inflation, and I would argue that being able to finance a home mortgage at 100 bps lower, and a dollar per gallon cheaper gasoline is better for businesses and consumers, and that this scenario is far better for fostering sustainable economic growth than the current scenario of QE2 and its effects. Really Better Off with QE 2? It seems regardless of what the inflation data says is the overall inflation rate in the economy, QE2 gave us all the negative, anti-growth, lowered standard of living type of inflationary effects that act as a major tax and headwind for both businesses and consumers going forward, and very little of the much needed “Record GDP Growth” and “Eye-Popping Job Creation” bang for our costly buck. Right Back Where We Started The real fear and irony is that once the full effects of QE2 are realized in the US economy, that we start reacting to said inflationary effects both through tightening monetary policy and consumer/business behavioral changes, and the US starts giving back some of its recent economic gains, and becomes vulnerable to the very scenario that the Fed was trying to avert in the first place, a double dip, deflationary downturn in the economy. Source: Dian Chu, EconForecast, March 6, 2011. 1 comment to QE2 – an unmitigated disaster?Leave a Reply | |||||||||||
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Bernanke’s Impossible Inflation Challenge 2011 – beta http://www.youtube.com/watch?v=n9n2Wo5O9wQ