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What Will the Fed Do When QE2 Fails to Stimulate Economy?

Posted by Larry Doyle on October 29, 2010 5:56 AM |

Here we are a full three years into our economic malaise, Uncle Sam has thrown everything and the kitchen sink at the economy yet we have little to no traction in terms of growth and momentum. Will another trillion dollars of liquidity do the trick? Well, while the Fed’s liquidity may move markets, will it move the economy? Don’t bet on it. The Fed and its brethren on Wall Street and in Washington are reluctant to truly level with the American people. How so?

Our nation is experiencing a serious structural change in our economy — not a mere ‘enormous downturn’ in the midst of the business cycle. If our central bankers and government officials were to emphasize this point, it may cause a sharper retrenchment in our current growth but it would likely lead to a quicker rebound. Before we get into why our bankers and their political cronies are reluctant to make this acknowledgement, let’s take the pulse of an array of venture capitalists, money managers, and others who provide the capital to a wide array of companies. What do these individuals think the economic impact of another round of quantitative easing might be?

Bloomberg addresses these outlooks today in reporting, Schwarzman Says Fed Easing Won’t Make Much Difference:

Stephen Schwarzman, chief executive officer of Blackstone Group LP, the world’s biggest buyout firm, said another round of asset purchases by the U.S. Federal Reserve won’t have much of an impact on companies. “It’s not an enormous incentive to do something different with your businesses because rates are down a few basis points,”…

Not exactly what Bernanke and Geithner want to hear. Anybody else with an opinion?

“Us printing money to buy our own bonds I don’t think can matter long term,” Cliff Asness (of AQR Capital Management) said this week in an interview with Bloomberg News at the Buttonwood Gathering, a conference organized by The Economist magazine in New York.

0 for 2. Anybody else?

Colm O’Shea, who runs London-based hedge fund Comac Capital LLP, told investors in August that the Fed would “risk its credibility” with a second round of quantitative easing.

Risk its credibility? Really?

What credibility?

Tony James, president of New York-based Blackstone, said today he wasn’t convinced pushing borrowing costs lower would have a positive effect on the economy.

The fact is all of these individuals are correct. But let’s check in with the man who runs the largest bond fund of all, Pimco’s Bill Gross. What is his take on the next round of quantitative easing? Well, we have to go overseas to the UK-based The Telegraph which highlights, Pimco Likens U.S. to ‘Ponzi’ Scheme:

“[Cheque] writing in the trillions is not a bondholder’s friend; it is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme,” he wrote on his investment outlook, arguing that creditors have always expected to be paid out of future growth. “Now, with growth in doubt, it seems the Fed has taken Ponzi one step further,” he said. “The Fed has joined the party itself. Has there ever been a Ponzi scheme so brazen? There has not.”

Could all these money men be wrong and QE2 will stimulate the economy? No, not at all. The simple fact is I believe the central bankers and our Treasury secretary are fully aware that the economy is in a significant disinflationary and likely deflationary trend. The QE2 may spark some asset inflation and consumer inflation (food, energy) but the downward pressure on wages and real estate will continue. Consumers will get further squeezed. Future generations will simply get stuck with another problem. That is, how to unwind the monstrous mess inside the Fed.

Why is it that our wizards in Washington do not address the ongoing structural changes in our economy? Great question. I would offer the following comments:

1. Structural changes take time to develop and time to address. Politicians in Washington are typically looking only to the next election cycle. As a result, these politicos on both sides of the aisle are less interested in making sacrifices and laying the groundwork necessary for future payoff. Just throw money at it now under the guise that we are doing our best. Fairly pathetic approach if you ask me.

2. Spending money on wasteful and marginally beneficial ‘pork’ projects brings votes. Implementing policy which facilitates private sector growth is harder to quantify and harder to ‘monetize’ in terms of immediate political payoff. Additionally, private sector growth is not exactly consistent with the Obama plan of redistribution.

3. How many politicians know the difference between structural and cyclical? I’m serious.

4. What should be done? In my opinion, forget the quantitative easing. Uncle Sam should: (a) provide a payroll tax holiday; (b) take some portion of the money targeted to QE2 and put into the community banking system with directives that it must be lent to solid businesses whose credit lines were cut; (c) leave the capital gains tax rate at 15%; and just for good measure, (d) replace Mary Schapiro and compel FINRA to open its books and records. Americans know the incestuous Wall Street-Washington relationship crippled our economy, but we would still like the specifics.

We deserve those answers.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. As President of Greenwich Investment Management, an SEC regulated privately held registered investment adviser, I am merely a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

Larry Doyle

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