QE2 is Damaging the Economy and Reducing GDP Growth

asiablues's picture
By Dian L. Chu, EconMatters

QE2 is going to go down as one of the worst monetary policy initiatives in the history of the modern Federal Reserve era. On almost any metric applied, QE2 ends up not only falling well short of its proposed goals, but actually turns certain metrics like GDP growth negative compared with the prior quarter, and heading in the wrong direction.

Costs Eat into Corporate Profits = No Hiring

Analysts all over Wall Street are starting to revise their 2nd quarter GDP forecasts down, and some like Goldman Sachs have made several downward revisions as higher input costs due to a weak dollar are creating an additional burden on businesses and consumers and thus slowing economic growth.

A weak dollar (Fig. 1) to a point can help exports, but an extremely weak dollar which in combination with QE2 liquidity juicing up commodities even further, turns out to be a net negative on the economy, and risks sending the economy into another recession.

The reason for this is if businesses are having to eat higher input costs, and start to have lower margins, guess what? They start cutting costs again, and that means either stagnant employment practices or workforce cuts in the future. This would start sending the employment figures in the opposite direction, and negate much of the recent progress made over the last year.

Increase Cost of Living = Consumer Pullback

These higher commodity prices negatively affect consumers as well because they have to apply more of their income to food and energy needs, which means they have less discretionary income to spend for entertainment, retail shopping, vacations, traveling, and discretionary consumption which infuses the economy and creates jobs in the overall economy.

And since the US is largely a consuming nation, if the consumer pulls back, then businesses are going to pull back as well. This linkage of events does not bode well for employment growth, and this shows how rising input costs not only hurt one of the fed`s mandates for price stability, but can also have a negative impact on their other mandate which is to increase employment.

Increase Consumer Debt…& Defaults

There is another angle we saw back in2008 with these same level of gas prices. Namely, consumers were feeling pinched by the jump in costs for food and energy (see charts below), so they started filling out credit card applications, and charging up their credit cards in order to pay for the additional costs to their weekly and monthly budgets for food and energy. In short, the higher costs for these items resulted in more debt for consumers.

This means that the recent gains of consumers paying off their debts, and having more money to spend at retailers over the past year will start to reverse as consumers pay a higher percentage of their monthly budget in finance costs. The real damage starts to add up as consumers start to default on their credit cards as the high food and energy costs continue to be financed on credit cards until the consumer hits the breaking point, and just defaults.

We saw a lot of this in 2008, and this is where we are heading again unless commodity prices start to come down in a rapid fashion. There are a large group of consumers whose monthly budget doesn`t allow for a 30% increase in gasoline prices at the pump, or a 10% rise in food costs at the grocery store. So they just pile up debt until they max out their credit cards.

Dominos to Credit Card Issuers

These increases in credit card defaults hurt businesses like banks and credit card firms as they have to write off more accounts, and thus their margins start to get squeezed. This means additional contractionary effects as they respond by cutting costs, and you can readily see how this starts to become a vicious deflationary cycle.

Deflation by High Commodity Prices

This is why high commodity prices are actually deflationary in the long run. Something the fed should think about the next time they embark on a dollar weakening campaign, whether intended or not QE2 has been a dollar weakening campaign.

And for those of you who still do not understand the chain of events, and how the Federal Reserve is responsible in large part for higher commodity prices here is the chain of events.

  1. The Fed undertakes QE2 Initiative – States goal to raise asset prices 
  2. Assets trade as a group: Equities, Silver, Gold, Oil, Gas, Corn, Soybeans 
  3. The US Dollar is used as a carry trade with such low fed funds rate (0-.25%) 
  4. The Fed encourages investors to take more risk: Go out of safe assets like bonds, and go into riskier assets like commodities and stocks. 
  5. When traders take on more risk, they use more leverage-This means shorting the dollar, as part of the carry trade like a funding bank, to use these additional funds (leverage) to invest in risk assets like Gold, Silver, Oil and Dow Stocks. 
  6. The trade starts to work, reinvest profits to buy more risk assets. 
  7. Strong Trends emerge, attracting other traders looking to capitalize on trending markets. 
  8. Technical Analysis confirms the validity of the trade –The trade becomes self-reinforcing 
  9. The dollar is shorted more for leverage, other currencies strengthen against the dollar 
  10. Dovish Fed talk serves to reinforce the trade further, dollar weakens more. 
  11. OH NO! The US Dollar is falling apart, fear spreads: Investors really buy Commodities as an inflation hedge.  
  12. Other countries like China start worrying about a falling US Dollar: They hedge by investing in Commodities. 
  13. Higher Commodities = Higher Input Costs for Businesses and Consumers 
  14. Results in Lower Business Margins and Less Consumer Discretionary Income  
  15. Higher costs, lower profits, less consumption, less goods being sold and produced 
  16. Lower GDP Growth Rate as a result of QE2 once the US Dollar reaches critical level where commodity prices rise to the breaking point where businesses and consumers pull back.  
  17. QE2 Actually damaging the economy right now.

Currency Crisis Looming

So you ask, and I am sure this is the Fed`s thinking on this matter. Well, what can just another two months of QE2 do to hurt the economy? It is almost over anyway. Let`s just continue it through to the end. Well, it is that very thinking that has investors and foreign governments concerned about the future and stability of the US Dollar.

A lot of countries and investors rely on the dollar as a store of value for their assets because it has the Reserve Currency Status. It can be weak, but if global investors start to have legitimate doubts about the safety of their assets parked and backed by the US Dollar, then we have a much bigger problem than just a slow recovery. We could end up in a currency crisis that takes down the entire global economy, thus sending us right back to where we were in the depths of the financial crisis.

Silver Market Signals Irrational Investing

But that is more macro analysis, and things would really have to spiral out of control to get to that stage, but it is possible, and that is why people are worried enough to buy physical Silver at $50 an ounce when it very well could be worth less than $20 an ounce once the rate tightening cycle begins. It makes no rational investing sense to buy Physical Silver during a low rate environment, because the investor will be stuck with a well under water investment in a 5% rate environment, unless there are legitimate concerns about the long term stability and security of the currency.

The time to buy Physical Silver was when the Fed Funds Rate was 5.25%, and the time to sell Physical Silver is now during the last vestiges of an equivalent Zero Fed Funds Rate. This irrational investing in the Silver Market, based upon concerns regarding the long term stability and security of the US Dollar, is one of the unintended consequences of the QE2 Initiative, and from a macro standpoint should raise a few eyebrows within the Federal Reserve.

Micro & Macro Effects

The Federal Reserve should weigh not just the Micro benefits to a policy initiative, but also the macro effects as well. Furthermore, there are many unintended consequences and macro concerns created by the QE2 Initiative that merit careful study to avoid some of these same mistakes being repeated in the future by monetary policy initiatives.

However, the more practical concern for the Fed is this--If they leave QE2 to finish out on course, and attach some dovish language to boot, investors will add another 50 cents to the price of gasoline at the pump, food prices will go up another 3 to 4%. After all, they have to pass on higher transportation costs to consumers. Businesses can expect higher commodity input costs for the next two months. The US Dollar will get even weaker, and GDP will be affected even more, as two additional months of damage will be pushing through the US Economy and Supply Chains. So this could result in the third quarter GDP be even more significantly revised down by economists.

Benefits of Ending QE2 Early

This is all to be juxtaposed with the alternative of ending QE2 early, which would lead to the US Dollar strengthening, and send a strong message to speculators, driving them out of commodities, and immediately reducing input costs for businesses and consumers. This cycle becomes reinforcing which leads to a further lowering in commodity prices as funds flow out of this asset class, thus providing an instant and even greater stimulus for the economy.

In essence, the ending of QE2 this month, serves to jumpstart GDP Growth for the remaining two months of the 2nd quarter, which will then build some momentum going into the third quarter, and should boost 3rd quarter GDP growth, and set the stage for a robust 4th quarter GDP number.

Significant Two Months 

The momentum is the key; you either have an accelerating economy or a decelerating economy. And right now due to the effects of QE2 we are starting to decelerate, and another two months of deceleration makes it twice as hard to restart the acceleration process. So two months could make a huge difference in either creating or destroying momentum, and setting the growth rate pace for the remainder of 2011.

The choice is obvious when asking the question regarding would the economy be better off without QE2 for the next two months? It is a resounding yes! Why this is even an issue at this stage seems more to do with the Federal Reserve saving face, than based upon any sound economic analysis of the facts at hand.

Give Consumers a Break

If President Obama wants to address the speculators for raising gasoline prices for consumers, he might want to investigate the real culprit in QE2. The easiest way to give consumers a break at the gas pump would be to end QE2 this month. The price of Oil, priced in Dollars, would drop like a rock as the US Dollar strengthens if QE2 is suddenly stopped, and Gasoline prices also trading opposite a weak dollar would start dropping immediately at the pump as the US Dollar strengthens.

In summation, if President Obama wants cheaper gas prices for consumers over the next two months, then all he has to do is make a call over to the Federal Reserve. I hear they are having a meeting this week and are deliberating over the future of QE2.

EconMatters, April 25, 2011 | Facebook Page | Post Alert | Kindle


Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
TexDenim's picture

Agree with this analysis totally. The issue now, in the waning months, is how to wean the US economy from this addictive drug of QE2. I think that we have to expect a couple of months of pain -- a 10% correction in S&P, perhaps worse than that in bonds. If we can recover from that, then perhaps in hindsight we can say that Bernanke pulled us out of 2007/2008 with less overall pain than would otherwise have occurred, but that was likely attributable entirely to QE1, not this most recent extension. And I hope that Zimbabwe Ben is smart enough not to test the patience of America with any talk of QE3.

nah's picture

the federal reserve is not a neutral party in nothin'


if the military/industrial complex wants more money... from seniors/14yrolds/productive capitol/material resources... there wont be a debate thats not what we pay any of these guys for


there will be more money till we run out... fact is we vote too much

SparkyvonBellagio's picture

The ol'#6 is where they come a ridin' into town, a whompin and a whoopin' ever last thing thing in sight to within' an inch of it's life.



Then they do a bunch of shit to the women at the #6 dance that night.


Google/Youtube-  Blazing Saddles.

Stuck on Zero's picture

Expect nothing less than the Fed to just jerk everyone around.  Watch the Fed take these steps:

1) End QE2, declare there will be no QE3 because of public pressure

2) Crash markets and commodities everywhere and cause massive unemployment

3) Declare a mess and that they were right all along

4) Start QE3 with a vengeance

5) Cause skyrocketing inflation and massive starvation

7) Take over the world.

Why?  Thanks to insider information passed out by the Fed to the billionaire banksters they have made trillions in the markets.



bothsidesnow's picture

#1 Check

# 2 Should read crash speculative bets by removing the dollar carry trade and bringing the dollars home where they belong. 

# 3 Look like stars when Europe and the Emerging markets puke

# 4 No way

#5 Not if liquidity is removed

#7 Taking over the world is one sided bet casinos only work when there are two side to the trade and the house i.e. the Fed is skimming the vigorish so to speak.

You forgot # 6 Have dinner with Blythe and Jamie. LMFAO.


longorshort's picture

Almost everyone here bashes the silver bears, the shorts, and anyone skeptical.  I see people calling 150 dollar silver on these boards.  I see Clarks Jewelry, not a pawn shop, advertising in a big cheesy sign that they buy gold silver and diamonds, pawn shops, the radio, the internet, the stock boards buying, people saying its not a top because on X or X% of their friends have bought XYZ yet.  The dollar droped what about 22% in last 8 years give or take a percent and physicals are up way over a 100%.  If it were me I would be taking a profit.  Its really not real till you sell.  Profit is better than loss.  Here is the other thing that bothers me about this commodity bubble, its the commodity groups like CME that are at fault as well as the government regulators.  They are selling more contracts than can possibley be filled and instead of limiting the number of total contracts based on % of real physical available with established accounting practices there is probably a trail that makes the MERS mortgage system look better than Canadian banks right now LOL.  I am being sarcastic there.  Instead they keep hiking margins and limiting the number of contracts individuals can get but keeps making exceptions for large players.  This will end badly when one large invester launches the crapstorm on another.  If you have craploads of physical do you think thats going to be easy to offload, best of luck.  If your hedging for the end of the dollar only, I think id rather have some name brand canned goods I like to eat and gameboy batteries to keep from being too boarde vs a  pile of silver well thats not too tastey but works great on wearwolves I hear.  I own some physical and have not shorted yet.  But if this thing keeps going I may have to come try to take a bear crap on this parade.

bothsidesnow's picture

Reminds me of watching Art Cashen during the crash of 2008 always sticks in my mind

"Bettting on the end of the world is not a good bet it only happens once."

Oh I forgot the guns and ammo crowd will survive and trade their physical with each other because the rest of us fucktards will be dead or starving. That's just a bad bet if you in anway believe in karma.


alexwest's picture

i cant stand stupid bitch's words anymore
please send her back where she belongs, some shithole back in China/HongKong/etc

#The time to buy Physical Silver was when the Fed Funds Rate was 5.25%

no stupud bitch, when Fed Funds Rate was 5.25 it was time to buy 30y bond.

##Silver Market Signals Irrational Investing

no stupid bitch, market simply says THERE'S NO PHYSICAL SIVLER .. read Eric sprott. at least he manages real money,not blubbering endlessly here..

#because the investor will be stuck with a well under water investment in a 5% rate environment

no stupid bitch ,, US federal goverment cant have Feds fund rate at 5% again, its that simple.. 10y will be 8-9%, so debt servicing will half of budget..

so USA FEDERAL GOVERMENT cant have only 2 choices ahead - zero rate 4ever, then hyperinlation


Sutton's picture

Bernanke will NEVER raise rates.

slow_roast's picture

But there is no inflation Dian; put a Chu in it.

Gimp's picture

Last I heard, the gubbermint said there was no inflation...

Korrath's picture

More babbling Captain Obvious bullshit from a silver shorter with an agenda.

Market Analyst's picture

Your the best writer on ZH, keep up the excellent work:)

Market Analyst's picture

Your the best writer on ZH, keep up the excellent work:)

Market Analyst's picture

Your the best writer on ZH, keep up the excellent work:)

Wm the Shrubber's picture

Pretty one dimensional analysis.  Should the Fed end QE2 early (if ever), the corollary of a strengthening dollar would be rising interest rates and a tanking of the risk trade for commodities and equities.  It is inconceivable that the real economy has sufficient organic strength to withstand higher rates (not to mention the government's increased debt servicing obligations), and a significant market reversal would undue the Fed's good handiwork of promoting the weath effect, their only purported accomplishment to date.  This may in fact be the plan thus setting the stage for a subsequent QE3 (though not so named) just in time to juice markets once more heading into the election year.  It is total clusterf*ck!

Zodiac's picture

Excellent points.  Who will buy those U.S. Government debt instruments, if not the Fed?  The traditional buyers, the Japanese won't be there.  The Chinese still need massive consumer buying for their products in the U.S. so the U.S. and China are like Siamese twins.  They might, or both will go down together.  But still, the supply of Treasuries has gotten ginormous.  Not to mention the interest burden.

Arkadaba's picture

No expert but agree with your post. Any analysis has to take into account the inevitable higher interest rates if QE ends. No matter any way I look at it, we're screwed.

Thomas Jefferson's picture

This article is garbage.

Thomas Jefferson's picture

This article is garbage.

Thomas Jefferson's picture

This article is garbage.

disabledvet's picture

How can this possibly be knowable by a "mere mortal"?  We all know it is not when the Fed itself admits as it must that "it's because equity markets are rising."  In other words THEY have no clue.  The whole thesis behind "Waiting for Godot" is that "Godot never comes."  And so it is with so much that clever humans do..."they do nothing" and "nothing comes."  And so it is with QE2.  "The Fed has done nothing" and "nothing happens"--so we must "move along."  this is in NO WAY saying "should massive failue in a treasury auction occur followed by an immediate repudiation of the dollar as exhibited by a single ounce of gold costing $30,000 ($300,000) US dollars an ounce and "simply no more food at Wal Mart et al..for now" won't occur nor be the fault of the Fed should it happen.  All this comment is saying is "good luck blaming 'them' should this speculation prove true."  Of course there is a thrill not only "having the speculation be proven true in a matter of days" (ZH on CME and silver) but to then be called "an enemy of the State" by no less than the President himself!  A compliment that I am paying you as well?  I would like to think so.

duncecap rack's picture

Copper silver gold and crude all going down on the eve of the fomc meeting. Coincidence?

SparkyvonBellagio's picture



Bernank has No Idea what he is doing.

Bernank will KILL THE USA as a viable Country going forward.


The USA won the Revolutionary but lost the Banking War!

The FED and BERNANK are pissing&sheeeitting on the memory of all of those who fought, those that gave the ultimate sacrafice for this Country, our Founding Fathers and the Constitution!

Don't let them do it folks!




LudwigVon's picture

The FED and BERNANK are pissing&sheeeitting on the memory of all of those who fought, those that gave the ultimate sacrafice for this Country, our Founding Fathers and the Constitution!

It goes deeper than that, Rothschild funded the British, we still won tho.

They have sought to leech our country since day one and have accomplished that feat no less than three times in our short history as a Republic. The constituion was specific in prohibiting this, but the politicians subvert that trivial issue, lie under oath and summarily sell their fellow countrymen and their children. TREASON --> HANGING.

NewThor's picture

From Bloomberg

The Fed’s trade-weighted dollar index fell to a record low last week, according to data released yesterday. The index, which tracks the value of the dollar versus the currencies of U.S. trading partners such as Japan and the U.K., declined to as low as 69.0337 on April 21, the data showed.

“We expect the Fed will leave its policy rate on hold,” said Mike Jones, a currency strategist at Bank of New Zealand Ltd. in Wellington. “Should Chairman Ben S. Bernanke indicate the Fed is in no hurry to start reversing policy accommodation, further dollar weakness may be on the cards.”

The U.S. central bank will leave its target rate for overnight lending between banks at zero to 0.25 percent at its two-day meeting starting today, according to another survey. The Fed may say it plans to complete the purchase of $600 billion of Treasuries by June.

Ben Bernanke says "I am Shiva, destroyer of worlds."

VegasBob's picture

The Fed is clueless.

Execute Bernanke!

OldPhart's picture

Won't do any good.  The Fed is a thirteen headed hydra.  Gotta get them all at the same time...along with the underlings.