It was just three short years ago that you could throw a dart and likely pick a winner; then reality struck! The real estate bubble collapsed, credit markets dried up, and poor investment decisions brought down some of the largest financial institutions.
The Federal Reserve, in its best efforts to contain this maelstrom, chose to inject money into the financial system in an attempt to boost liquidity and spur consumers to buy. By all accounts, so far, despite the government's buying some very poor assets from some of the nation's largest banks, this original quantitative easing accomplished its goal. People were buying stocks again, and the banks had ample liquidity to lend.
Last week, the Fed announced that it would undertake its second round of quantitative easing, aka QE2, beginning now and ending in the second quarter of 2011. At stake is another $600 billion, which the Fed will essentially print out of thin air and use to purchase U.S. Treasuries in order to lower long-term interest rates and drive an economic recovery. Putting hope aside, my thoughts are that Chairman Ben Bernanke and the Fed have made a costly long-term error.
Spare some change?
First, it's very unlikely that we'll be able to see the long-term inflationary effects of this quantitative easing for some time. Blindly printing money to spur the market could wreak havoc on commodity prices, as fellow Fool Dan Caplinger points out.
Gold, silver, oil, coffee, corn, and cotton are all at or within reach of multiyear highs, which spells trouble for both your pocketbook and company expenses. At Wal-Mart (NYSE: WMT ) , rising gold prices could eat into jewelry margins and push prices higher. Kroger's (NYSE: KR ) margins may suffer from rising food prices if it does not pass that increase to consumers. Likewise, rising coffee prices have necessitated Starbucks' (Nasdaq: SBUX ) raising its prices. No matter how you look at it, margins are being squeezed and everyone suffers.
Even more problematic is the negative impact QE2 has on the U.S. dollar. Sure, a lower dollar helps in the short term by making U.S. exports considerably more competitive, but it makes it considerably harder for Americans to travel. Fewer people taking vacations and a rising inflation scenario might spell trouble for a company like Carnival (NYSE: CCL ) , which relies on a steady stream of vacationers and lower fuel prices to be profitable.
The double whammy is that if you decide not to travel, since oil is often denominated in dollars, and dollars are weakening, the cost of oil and gasoline may rocket higher, trapping you in a no-win situation.
Looking at QE2 from a foreign perspective makes this look even bleaker. By printing money, the U.S. is devaluing its debt by driving down the price of the dollar. China and Japan purchasing U.S. debt has been one of the few bright spots up until now, but if future debt purchases are going to be met with continued devaluations, it's possible that these countries may look elsewhere with their capital. Not only could this stymie U.S. growth, but as I mentioned earlier, increased U.S. exports could hurt growing economies like China.
House of cards
Housing could be one outlying factor that could be at the heart of QE2. The Fed injected $1.25 trillion into various economic instruments meant to buoy the banks behind the mortgage crisis in 2008-2009 and I highly doubt they'd let that money go to waste. By driving down Treasury yields, the Fed will hope to artificially enhance the "wealth effect" by causing investors to jump into stocks and potentially move the overall market higher.
The problem here is that the housing market simply can't be buoyed by artificially pumping money into the system. Eventually the market needs to account for the massive glut of foreclosures and the continued slide in housing prices. Until the market can genuinely cope with the reality of the housing market, I doubt QE2 can successfully create wealth given how most Americans' wealth is tied to their homes.
I also find the timing of QE2 to be suspect given that we're seeing the highest rate of variable-rate mortgage resets in three years. This time we'll be fine from a liquidity perspective, but with homebuilders taking writedowns on large inventories -- such as KB Homes (NYSE: KBH ) , with $129 million so far this year, and D.R. Horton (NYSE: DHI ) with a writedown of $31 million in its latest quarterly report -- it's a sign that the market hasn't properly adjusted itself yet. A steady stream of foreclosed properties on the market simply will not allow these excess homes to sell.
Final Foolish thoughts
The Fed and Bernanke appear to be in the driver's seat, with their blinders on and heavily under the influence of the artificial wealth effect. Just like the commercials warn you, sometimes you have to "know when to say when," and Ben Bernanke, QE1 was more than enough!