Quantitative T-Easing: The Truths About QE 2

For many, the world's largest central bank -- the U.S. Fed -- once personified a stern, all-knowing parent. Whenever anyone dared to peep "Why?" after a difficult decision had been made, the bank answered with four simple words: "Because I Said So." And with that, the conversation was over.

That was then. But, according to a slew of recent news reports, the "don't-fight-the-Fed" kinda days are numbered. (See "Faith in the Fed's leadership is evaporating" in the December 7 Forbes, for example.) And so, perhaps in an attempt to reclaim the public's respect, Fed chief Ben Bernanke has gone where very few Fed heads before him have: primetime. On December 5, Bernanke went on national television in a rare "60 Minutes" interview to defend the board's latest monetary campaign -- the second round of quantitative easing, a.k.a. QE2.

Judging from the reviews -- "Mendacity Ben," (Seeking Alpha) "Ben: Pants On Fire," (Forbes) and "60 Minutes: 1 Failed Fed" (AP) -- I'd say, Bernanke failed to sway the masses into QE2's favor. For many, one of the last supposed aces up the Fed's sleeve is looking more and more like a Joker. 

We at Elliott Wave International are not surprised. Two months ago, our October 2010 Elliott Wave Financial Forecast asked: If quantitative easing were so effective at propping up the fledgling economy, then why do we need a second round of it? After all, the Fed had already tried QE1, for almost two years: from September 2008 to June 2010!

That's probably the most obvious concern. Other supposed effects of QE have also been thrown into doubt recently, including:

1. "QE2 will create jobs and bring down the unemployment rate."

The month QE1 began (September 2008), the U.S. unemployment rate stood at 6.2%. Today, it's hovering near 10%.

2. "QE2 will batter the U.S. dollar and bring high inflation."

Today, the U.S. Dollar Index stands higher than it finished at the end of September 2008, despite the in-between ups and downs. As for inflation, a November U.S. government report showed the underlying inflation rate at .6% -- the lowest level since records began in 1957, and well below the Fed's informal inflation target of 1.5% to 2%.

3. "QE2 will aid in creating an accommodative lending environment and reduce interest rates."

Since QE2 began, long-term interest rates have actually gone UP.

4. "QE2 will stimulate loan creation."

"From September 2008 to June 2010 a $2.46 trillion ($1.43 trillion in assets and $1.03 trillion in excess reserves) increase in the Fed's balance sheet coincided with a decline of $296 billion in total US credit market debt outstanding. Consider also that up until 2008, the total credit market debt rose for 63 consecutive years."

5. "QE2 will reestablish the Fed's credibility and authority"

"The Fed has $912 billion worth of assets. A year ago, most of its assets were Treasury bonds. In the past year, it has swapped more than half of its formerly pristine portfolio for mortgages and other bank debt. Before August ends, the Fed's ratio of Treasury holdings will fall below 50% for the first time ever. This will mean that the Federal Reserve is no longer the 'federal' reserve."

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