The Experts Give Us QE II

The Fed's $600 billion promised purchase of Treasury bonds over the next eight months gathered the headlines, but the fine print adds an additional $35 billion per month to purchase more Treasury debt with proceeds from mortgage bonds the Fed plans to retire.  Total money created from nothing for the next eight-month period: $900 billion. 

The stock market is trying to figure out if this is good or bad.  On Wednesday the Dow rose 26 points, and so far today it's up 188.83 points, currently sitting at 11,403.96 as of 3 PM. EDT.

But gold buyers reacted with horror to the Fed's plans.  Adrian Ash reports:

THE PRICE OF GOLD in wholesale dealing lept at the start of US trading on Thursday, extending an overnight rise to within 0.5% of last month's record highs – and gaining $50 per ounce inside 21 hours – as the US Dollar sank in response to the Federal Reserve's hotly-anticipated "QEII" asset purchase program.

"Currency devaluation remains firmly en vogue," said one London bullion dealer this morning.

Currently, gold is selling for $1,384 per ounce, according to Kitco. 

In a Washington Post Op-Ed piece, Ben Bernanke justified QE II this way:

Today, most measures of underlying inflation are running somewhat below 2 percent, or a bit lower than the rate most Fed policymakers see as being most consistent with healthy economic growth in the long run. Although low inflation is generally good, inflation that is too low can pose risks to the economy - especially when the economy is struggling. In the most extreme case, very low inflation can morph into deflation (falling prices and wages), which can contribute to long periods of economic stagnation.

Even absent such risks, low and falling inflation indicate that the economy has considerable spare capacity, implying that there is scope for monetary policy to support further gains in employment without risking economic overheating. The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed. With short-term interest rates already about as low as they can go, the FOMC agreed to deliver that support by purchasing additional longer-term securities, as it did in 2008 and 2009. The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.

And Mish's Global Economic Trend Analysis mentions the views of Dr. El-Erian, CEO and co-CIO of PIMCO, who predicts QE II will fail for at least three reasons:

1. The Fed is going it alone, without meaningful structural reforms
2. Emerging economies burdened by capital inflows in the wake of QEII will react with currency wars, protectionism, and capital controls
3. Resultant commodity price increases will increase input costs and reduce earnings of American companies

The only structural reform that would help us would be to de-structure the Fed entirely, along with every other organization in Washington.  Mish offers his own analysis:

Add a junk bond bubble to the list of consequences (unintended or otherwise).

Bernanke is clearly misguided enough and arrogant enough to purposely blow a junk bond bubble as an "intended consequence", even though the housing bubble bust proves without a doubt the asininity of such policies.

Thus, it's hard to say if Bernanke wants a junk bond bubble or is merely willing to live with one.

Then again, Bernanke is dense enough to not have any clues about what is happening. He did not see the housing bubble, the recession, the huge rise in unemployment, and any number of other things that happened. In fact, he even denied there was a housing bubble.

In the academic wonderland in which Bernanke lives, it is perfectly possible he is oblivious to the bubbles he is creating.

However, looking at things from every angle, given that Bernanke Admits Targeting Stock Prices, I am leaning towards the first option: Bernanke is misguided enough and arrogant enough to purposely blow more asset bubbles as an "intended consequence", hoping he can deal with them later.