Home > Best assets to buy, Best assets to sell, Predictions > Doug Noland’s definitive assessment of QE2

Doug Noland’s definitive assessment of QE2

We’re watching bifurcating bell curves, oscillating spinning tops slowly losing momentum and an unorderly wind-down of US fiat dollar hegemony.  There is no way this is going to end any way but ugly.


The late-July arrival of Federal Reserve of St. Louis President Bullard’s monetary policy white paper commenced serious discussion regarding “QE2.” From August lows, the S&P500 has gained almost 18%, the S&P400 Mid-Caps 21%, and the small cap Russell 2000 25%.  Notably, many global market prices have enjoyed even more robust inflation.  Gold is up 19% and silver has surged 50%.  The Shanghai Composite has rallied 22%.  India’s Sensex index rose 18% to a record high.  Copper is up 23% from August lows.  Cotton has surged 80%, sugar 82%, and corn 46%.  The Goldman Sachs Commodities index has gained 21% from mid-August lows.   

In Bill Gross’s latest, he posits that the Fed is “pushing on a string.”  This is not the case.  The current backdrop has little-to-no similarity to the 1930’s; the world is definitely not today stuck in a Credit collapse and deflationary quagmire.  Instead, much of the globe is facing an unrelenting onslaught of financial inflows and heightened inflationary pressures.  Faltering dollar confidence is the prevailing force behind troubling inflationary pressures and strengthening Bubble Dynamics.

Increasingly, “emerging” economy Credit systems have succumbed to overheating, while key developed economies are locked into a perilous cycle of massive non-productive government debt expansion.  Our unsound debt, liquidity and currency dynamics ensure that excess flourishes throughout global Credit systems.   Bubbles are today left to run uncontrolled and undisciplined by a market hopelessly distorted by liquidity overabundance.  Fed policies seemingly ensure that global liquidity goes from extraordinary to extreme overabundance.

The Fed may today be alone in “quantitative easing” through the purchase of domestic government obligations.  Our central bank, however, has considerable global company when it comes to monetization and liquidity creation.  From Bloomberg’s tally we know that global central bank international reserve positions have inflated $1.5 TN over the past 12 months.  That last thing the global financial system needs is an additional shot of liquidity and reasons to believe that dollar devaluation will be accelerated. 

In post-announcement analysis of the Fed’s commitment for another $600bn of Treasury purchases, Bill Gross commented on CNBC that “the biggest risk is inflation down the road.”  I again disagree with Mr. Gross.  The greatest risk is a destabilizing crisis of confidence in our nation’s debt obligations.  Our system doubled total mortgage debt in just over six years during the mortgage/Wall Street finance Bubble.  Washington is now on track to double the federal debt load in just over 4 years.  Federal Reserve policy remains instrumental in accommodating a precarious Credit Bubble at the heart of our monetary system.

It seems again worth highlighting a couple key sentences from ECB President Jean-Claude Trichet’s July 22, 2010 op-ed piece in the Financial Times, “Stimulate no more – it is now time for all to tighten”:  “…Given the magnitude of annual budget deficits and the ballooning of outstanding public debt, the standard linear economic models used to project the impact of fiscal restraint or fiscal stimuli may no longer be reliable. In extraordinary times, the economy may be close to non-linear phenomena such as a rapid deterioration of confidence among broad constituencies of households, enterprises, savers and investors.”

The Bernanke Fed is playing with fire here.  QE1 was implemented in an environment of deleveraging, impaired global financial systems and acute economic contraction.  And, importantly, the dollar was enjoying strong performance in the marketplace as global risk markets suffered from de-risking and general outflows.  QE1 had a stabilizing influence, as it worked to accommodate financial sector de-leveraging. 

The QE2 backdrop is altogether different.  Global markets are these days demonstrating robust inflationary biases.  Risk-embracement is back in vogue – speculation is rife.  The “emerging economies” and global risk markets have been on the receiving end of massive financial (“hot money”) flows.  Meanwhile, the dollar has been under heavy selling pressure with heightened risk of a crisis of confidence.  This week’s market activity supported my view that the environment would seem to dictate that QE2 will only exacerbate increasingly unwieldy financial flows and unstable global markets.

It has been critical to my analysis that current reflation dynamics are different in kind from those that for the past two decades provided the Federal Reserve the most potent mechanism for domestic monetary stimulus.  In today’s post-mortgage finance Bubble and housing mania backdrop, the Fed has lost much of its capacity to inflate household net worth and spending.  The robust inflationary biases – and fledgling Bubbles – are now in global markets and economies.  The “Core to Periphery” financial flow dynamic has become deeply embedded.

The key dynamic today is one where deep structural U.S. impairment elicits an unprecedented monetary response from our central bank.  Yet the markets anticipate that this liquidity will seek out the inflating asset classes and most robust global economies.  This week, gold climbed to a record high, crude oil to a two-year high, and copper to a 28-month high.  The Shanghai Composite jumped 5.1% this week and India’s Sensex was up 4.9%.  So far, indications support the view that the Fed’s move will further stimulate unfolding global booms. 

Whether it is Asia or the commodities economies, QE2 will exacerbate the already powerful financial flows and Bubble fuel.  The U.S. economy is poorly structured to benefit from these new global financial flows, inflation and growth dynamics.  There may be some gain from inflating U.S. stock prices.  Yet the struggling consumer sector is going to get smacked with higher food and energy prices.

In his Thursday op-ed in the Washington Post – “What the Fed did and why: supporting the recovery and sustaining price stability” – Chairman Bernanke argued that “the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability.”  The dilemma for the Fed is that the financial and economic environment will dictate that their policies have minimal impact on both U.S. employment and growth, while providing a major impetus for additional global Monetary Disorder.  A strong case can be made that QE2 will only worsen already unprecedented global imbalances.  Global policymakers must be at their wits’ end.

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