Prospects for QE3 Rapidly Diminishing

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Second quarter GDP was revised up from 1.5% to 1.7% this morning and the Fed's Beige Book this afternoon stated that modest improvements in the economy were taking place. So how can Fed Chair Bernanke justify a third round of quantitative easing? He can't.

Market participants (SPY - News) who are expecting a full-out statement supporting QE3 this Friday at the economic confab being held at Jackson Hole are likely to be sorely disappointed. Bernanke made such a statement in 2010 before the second round of QE began at the end of that year. The Fed leaked the information to the stock market even before that. It got maximum mileage in terms of juicing up stock prices as a result. A recovered economy however didn't quite materialize. If a third round of QE is being taken seriously, it indicates the first two didn't exactly benefit the economy as much as was claimed.

Seeing how successful they were in manipulating stock prices in 2010, the members of the FOMC (Federal Open Market Committee) are merely attempting to use the same playbook in 2012. Stories were planted in the mainstream media in June about how the Fed was going to do more QE. When that didn't materialize, there was an immediate segue to "they didn't do it this time, but will at the next meeting". Before the late July, early August meeting a front page story appeared in the Wall Street Journal that the Fed was determined to do something at the next meeting and the members of the FOMC were discussing more QE. The meeting came and went and no policy change was announced. The "they didn't do it this time, but will at the next meeting" theme immediately reappeared.

Last week, the minutes from the July 31-August 1st meeting were released and they did contain a lot of discussion concerning more quantitative easing. The members of the FOMC knew that this would become publically available information and would help move the markets up (at least for a while) even if they weren't intending to do anything. Even if they were, their hands are becoming increasingly tied.

The official economic numbers are mediocre, but QE isn't justified unless they are really poor. A GDP of 1.7% is not low enough to make the case for more quantitative easing. If it is, then the Fed will be printing money most of the time in the future. Retail numbers and the jobs report also supposedly showed some improvement after the last Fed meeting. The Fed Beige book, a broad survey of the U.S. economy, released this afternoon essentially said the economy was doing OK. The reasons for doing more QE are rapidly being undermined.

There are other problems that will prevent any casual QE from being done right now as well and they emanate from the presidential election. Republican candidate Romney has already stated more than once that he intends to replace Ben Bernanke as Fed Chair. Ben Bernanke doing QE before the election would be seen as a blatant attempt to help reelect President Obama and save his job. It would become a major political issue and bring scrutiny to the Fed's actions that it most certainly would like to avoid (the Fed constantly claims that it is politically independent).

There is one instance however where the Fed could justify doing QE before the election - if there is a breakdown in the eurozone. ECB head Mario Draghi and EU leaders are even better at promising and not following up with concrete action than is Ben Bernanke. Another round of major money printing on a global scale would be considered necessary as was the case during the Credit Crisis in 2008. Back then, it took six months of bombarding the financial system with liquidity before markets bottomed. Investors shouldn't be in any hurry to buy this time around either because stocks are likely to have a major drop once again if problems in Europe get out of hand. If it works at all, QE can take time to have an impact even on the stock market.

Daryl Montgomery is the Author: "Inflation Investing - A Guide for the 2010s"

Organizer, New York Investing meetup.



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