Quantitative Easing Is Destined To End In Tears As Commodities Rise
It’s hard to overstate just how astounding it is for the Fed to take aggressive action likely to push inflation higher when the Producer Price Index already is above 40-year averages. Yet in trying to push up aggregate demand in the economy, the Fed is doing just that. Its action will no doubt push consumer demand up somewhat, but it will cause an even greater acceleration in the elliottwave Producer Price Index and in particular in the prices of the commodities that underlie the index.
Stocks, too, should move higher. Fed Chairman, Ben Bernanke, has long held that gains in financial assets, which include stocks, are the economy’s best chance. In a 2002 speech, he said: “I suspect that operating on rates on longer-term Treasuries would provide sufficient leverage for the Fed to achieve its goals in most plausible scenarios. If lowering yields on longer-dated Treasury securities proved insufficient to restart spending, however, the Fed might next consider attempting to influence directly the yields on privately issued securities.” He went on to say “the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers.”
The second round of quantitative easing (QE2) is now a fact of economic life. Its purpose, according to the Fed’s volcone, is to ward off deflation and push down unemployment. Before handicapping its chance of success, we must point out just how extraordinary the Fed’s action was.
The producer price index, a broad measure of inflation—shows we’re nowhere close to deflation. Over the past 40 years, a period encompassing the inflationary 1970s, producer prices have risen by an average of 3.9 percent a year. The most recent figure is 4 percent.
Rising asset prices are especially important given that the federal government, hobbled by debt, isn’t likely to contribute additional fiscal stimulus. In that same speech Bernanke blamed Japan’s overhang of banking problems and government debt for the persistence of deflation in Japan. It seems clear that the implicit if not explicit goals of QE2 are gains in financial assets and increased consumer spending.
Those goals may well be achieved—but probably at the cost of setting the stage for a replay of 2008. Rising stocks and higher consumer spending will mean even greater gains in commodities, which as in 2008 will constitute an effective tax hike. For a time, investors will likely make money in a variety of real and financial assets, as they did following the last recession. Enjoy it while you can. QE2 will work for a while, with most assets gaining ground. Unfortunately, it seems destined to end in tears. It should be expected that the middle-class savings will get hammered by the new Federal Reserve policy. Thanks, Mr. Bernanke, for lighting the fuse.
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