Monday, November 8, 2010

More Thoughts on QE2


Lots of articles over the weekend on the Fed's latest gambit.

First, from an investor's standpoint, I think you have to go with the flow, and stay invested in stocks and bonds so long as the Fed wants to help you.

As this note from Barron's over the weekend discusses, you might be worried about the longer term implications of flooding a financial system that is already drowning in liquidity, but that is a question for debates, not investing.

Here's an excerpt:

"DON'T WORRY ABOUT the horse being blind; just load the wagon."

This sage observation of footballer John Madden, who apparently also has a deep understanding of financial-market dynamics, is good advice for anyone afraid the world soon might end because the Federal Reserve just wagered $600 billion in one of the most high-risk trades in the history of civilized man.

Yet the greatest risk is being too cautious on stocks during the next three to six months. Traders, investors, inveterate gamblers, dumb money and smart money are buying stocks and calls and even selling puts to profit from a potential tsunami-like shift into stocks, as the Fed effectively declares war on the interest rates critical to bonds.

The buzzword among traders is that "tail risk is to the upside," meaning stocks are much more likely to rally than not. The crowd is backing off from defensive index puts in listed and over-the-counter markets.

So, rather than getting self-righteous about the financial and moral turpitude of modern America, try to relax. Trade what is, not what is not.

Strategies to Trade on the Fed's QE2 - Barrons.com

That said, one certain aspect of QE2 is that we have managed to make the rest of the world angry at us. The overwhelming consensus from foreign leaders is that Fed's move is not only wrong, but will lead to a currency war that will hurt everyone.

One of the most strident criticisms has come from Germany. The comments from German leaders reminds me of the 1970's, when Helmut Schmidt used to regularly lecture Jimmy Carter and the rest of the U.S. political establishment about their fiscal policies.

Today, the German finance minister is named Wolfgang Schauble, and he thinks the U.S. is crazy. Here's an excerpt from an interview in Der Spiegel (I have added some highlights):

Schäuble: The German export successes are not the result of some sort of currency manipulation, but of the increased competitiveness of companies. The American growth model, on the other hand, is in a deep crisis. The United States lived on borrowed money for too long, inflating its financial sector unnecessarily and neglecting its small and mid-sized industrial companies. There are many reasons for America's problems, but they don't include German export surpluses...

SPIEGEL: Last week, the US Federal Reserve Bank decided to flood the economy with $600 billion in new money. Will this stimulate the economy as hoped?

Schäuble: I seriously doubt that it makes sense to pump unlimited amounts of money into the markets. There is no lack of liquidity in the US economy, which is why I don't recognize the economic argument behind this measure.

SPIEGEL: The US wants to depress the value of the dollar in this way, so that it can sell its products abroad more easily. In light of the ailing US economy, isn't that a completely reasonable strategy?

Schäuble: No. The Fed's decisions bring more uncertainty to the global economy. They make it more difficult to achieve a reasonable balance between industrialized and emerging economies, and they undermine the US's credibility when it comes to fiscal policy. It's inconsistent for the Americans to accuse the Chinese of manipulating exchange rates and then to artificially depress the dollar exchange rate by printing money.

http://www.spiegel.de/international/world/0,1518,727801,00.html

A lot of the current debate reminds me of the book Lords of Finance, where author Liaquat Ahamed discussed how the central bankers in the late 1920's and 1930's attempted to deal with a world struggling with weak economic growth, high unemployment and, yes, deflation.

Hopefully we will be able to avoid the same travails of the 1930's. So far, at least, recent economic releases have been promising.