We’re now nearing the end of QE2 and some concrete conclusions can be made.   I’ll save my overall analysis of the program until after its conclusion, but I think the impact of QE2 can be pretty much summed up with the following chart:

Economic growth peaked with QE2′s inception

Real GDP peaked as soon as QE2 began.  Now, this shouldn’t be shocking to anyone who has been reading pragcap over the duration of this program.  From its onset I said QE2 would do nothing for the real economy.  In fact, operationally, it could do nothing.  But its impacts actually appear to have been damaging to bottom line growth.  How so?  QE2 helped contribute to a massive surge in speculation in commodity prices.

You see, QE2 didn’t monetize anything.  It didn’t cause the money supply to explode.  It didn’t really do anything except cause a great deal of confusion and generate an enormous amount of speculation in financial markets that now appears to be contributing to turmoil and strife around the globe.  Operationally, it is no different than what the Fed does at the short end when they implement monetary policy.  The important distinction, however, is that this policy was implemented incorrectly.  Instead of targeting price they targeted size.  And the results in the bond market speak for themselves.  Rates have meandered up and down and up and down without a care in the world for the Fed’s $600B purchase program.  In other words, the program had no impact on rates.

Aside from targeting rates, the program was intended to generate a portfolio rebalancing effect.  I won’t repeat the comments I’ve made in the past or those of Richard Koo, but the portfolio rebalancing effect is essentially a form of putting the cart before the horse.  Creating nominal wealth without an accompanying real effect that results in real economic growth is very misguided and the worst form of ponzi finance.

Where we saw a real impact was in commodity prices, general price speculation and the financing pyramidI believe the BOJ has written the finest piece of research detailing this speculative effect.  The pass through effect from commodity prices is a contributing factor in the declining real GDP.  Inflation has risen marginally due to commodity price increases and the underlying real economy has remained stagnant.  In other words, QE2 caused margin compression without helping spur growth.  This helped create the disequilibrium I have often discussed. The result is the current air pocket in the economy.

Critics of this analysis are likely to claim that we don’t know what would have happened to the economy without QE2.  This is true of course.  What we do know is that the economy was growing at 3.3% at the time QE2 was initiated, ISM surged to 57 just days after the announcement and climbed to 58 as the program was beginning.  In other words, we can confirm, definitively that the economy wasn’t collapsing as QE2 was beginning, but weakened as the program progressed.

So, the only question left is – if the evidence appears to point to the fact that QE2 didn’t help the economic recovery then why in the world would anyone even consider QE3?

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. Does it really make sense to compare initiation of QE2 with GDP contemporaneously? As we all know, there is a lag in the transmission of monetary policy to the real economy. I think your chart simply indicates that QE2 was implemented in response to indications of a slowing economy.

  2. Wall Street loves the idea of QE because it thinks QE is “free money” and it likes the PD commissions. If the S&P gets close to 1000 the Fed will most likely announce QE3. It seems focused on the stock market and the wealth effect, and what other tools does it have left? Interest rates are very low already, but there is low demand for loans. Overleverage is the problem in the economy but the Fed doesn’t want the banks to take any writedowns. Markets don’t clear and uncertainty reigns. It’s self-defeating. Remember the RTC’s role in liquidating insolvent bank assets in the S&L crisis in the late 1980′s? One great big fire sale, and it worked.

  3. Don’t blame QE2 for commodity speculation. Just look at the history of trading volumes:

    Clearly there was a surge before QE2. This, as Bruce Krasting pointed out in May ( is a consequence primarily of ZIRP (in combination with QE).

    Bernanke took credit for causing the equity rally and washed his hands of the commodity rally, inferring that the Fed knew this would happen. I’m not convinced. I suspect that in 2008, the last thing on the Fed’s mind was triggering rallies, it simply wanted to save the banking sector. These rallies were an unintended consequence.

    As the graphs above show, QE2 did have an increased effect on commodity speculation, but said speculation was *already* very high. Surging commodity prices could have occurred without QE2 at all, QE2 just increased the odds. Having the Fed provide a monster bid in treasury auctions artificially suppressed yields, pushing fixed income (particularly pension funds) out of the market and into more risky speculation. At that time, stocks probably looked overdone, so attention spilled over into commodities.

    I really do think that QE2 was an attempt to push cash into the real economy via the government. The idea was right, but it simply didn’t work as planned. The unintended consequence of a commodity rally negated any benefit of QE2, forcing higher costs on Main St that offset the gains from government spending. Overall, taking leverage and ZIRP into account, the force of speculation easily exceeds that of injection from QE2, making the program a net negative for US GDP.

    Sorry for repeating it again, but I think QE3 WILL happen, probably not immediately given all the bad press the Fed has received over QE2 (which was FUBAR). There are lessons to be learned, and if they are, properly, QE3 could be done the RIGHT way, which would be to helicopter drop money to the peons and tighten monetary policy at the same time. ZIRP has to end.

  4. bill gross “the jobs number will not be an isolated incident. QE3 is likely”

    its their only tool

  5. “based on our concept of MFI credit”

    “The genesis of MFI credit is the Austrian school of economic thought’s concept of created credit”

    No, as Written June 1980 – Dr. Leland James Pritchard: BA, Political Science, MS, Statistics -Syracuse, Ph.D. Economics -Chicago, 1933:

    The DIDMCA became law on March 31st, 1980. The Act created the legal framework for the addition of 38,000 more commercial banks to the 14,000 we already had, and in the process, the abolition of 38,000 intermediary financial institutions. The intermediary financial institutions effected were the nation’s savings and loan associations, mutual savings banks, and credit unions. Trust companies and stock savings banks have been commercial banks for many years…

    MFI’s are money creating depository financial institutions (or called DFIs by the frbST’s research staff).

    Just like the TMS money supply concepts, the Austrians are always copying the Chicago School.

  6. Also, Paul Kasriel missed one big money creating depository institution (which should be included in his “MFI”).

  7. Fellow Prag Cap readers,

    Mark my words – the destruction of the US economy is not an accident; it was planned by the banking elites (illuminati).

    The end game is one world currency, one central bank and the new world order.

    The Euro was brought in a few years ago and the Amero will soon follow. These banksters want total control of the world – he who prints the money, rules the world.

    Governments are just puppets put in by the banking elites (Rockefeller, Rothschilds, Morgan, Warburg families) as a smokescreen so that people can continue to blame these pigeons. Obama, Bush, Merkel, Sarkozy – they are all puppets being controlled by the illuminati families.

    The idea is to indebt the society to such an extend that people beg for a solution – that ‘solution’ will be the introduction of the Amero followed by one world currency (probably many decades down the road).

    The Fed is an inflation machine – under its rule, the Federal Reserve Note (wrongly called the US Dollar) has lost over 97% of its purchasing power. The Federal Reserve system is a SCAM, a facade – its real objective is to protect the banks, extend unlimited amounts of credit (so that is can collect interest on money which it creates by a click of a mouse) and bankrupt nations.

    The Fed has done a super job so far and served its masters perfectly.

    Bernanke and Greenspan are not stupid – they have carried out the agenda perfectly.

    Wake up people and buy gold, silver and get out of debt.

    The collapse is here. Wake up for Christ’s sake!!!!!!!!!!!!!!!!!!

  8. can anyone explain the meaning and effects on a country’s balance of payments when “every dollar that a govt issues is backed 100% by foreign reserves”?

    i don’t quite understand the statement… for example;

    1) govt spends 1000
    2) govt taxes 600
    3) so 400 is in the hands of the private sector & the govt owes that to the private sector

    the only way i can make sense of the above statement is if the govt takes 400 of the 600 it receives in taxes, and uses that to buy a foreign currency. in that sense, money isn’t exactly destroyed.

    oh wait, did i just describe the China-US treasuries affair?


    • That article shows a frightening lack of understanding of modern banking. The fact that the article even mentions that reserves are lent out makes it clear that the premise is flawed. The idea that QE2 improves the capital position is also wrong. I’d just ignore the whole piece. The only way QE2 becomes a bank bailout is if they swap out more of the risk assets such as MBS or other such high risk assets.

  9. It seems that the Fed has a single goal and that is to support the equity markets and the “risk on” trade. A decline or slowdown in GDP growth appears to elicit a yawn at best whereas a stock market correction of 20%+ will guarantee QE3 no matter what it may or may not do to GDP.

  10. <>

    Bingo! The Bernank mainly cares about the big banks. I wish this weren’t true.

  11. My above comment was in response to this quote:

    “QE3 wil come along to save the banks from the effects of the next deflationary event, not to help the masses.

    It’s not rocket science, it’s as plain as day. “