Forget About QE3 - It's Not Going To Happen

by: David Frazier

During the past few weeks, several financial market journalists, stock market pundits and Wall Street economists have said that they expect the Federal Reserve to soon initiate another round of quantitative easing.

Morgan Stanley's Chief U.S. Economist, Vincent Reinhart, went so far as to say on March 6 that his firm expects the Fed to undertake additional balance-sheet action during the first half of 2012. Specifically, Reinhart, who is a former director of the Federal Reserve Board's Division of Monetary Affairs, said, "The most likely form of that action is open market purchases of Treasury and mortgage-backed securities funded through the creation of reserves - Quantitative Easing 3 (QE3) - at the April or June meetings. We expect it to total around $500 billion to $700 billion."

Yet, my research indicates that the Fed will not initiate another round of substantial monetary easing - or what journalists refer to regularly as QE3 - during the months ahead. That's because U.S. commercial banks already have a massive amount of funds on deposit that they can lend to households and businesses as a result of the huge amount of new money that the Fed created between August 2008 and May 2009. Hence, there's no reason for the Fed to implement a new round of quantitative easing.

Although the purpose of those monetary actions was to lower lending rates in an effort to incentivize U.S. households to increase their borrowing and spending, those interest rate cuts have done little to stimulate such actions or to increase the pace of economic growth in the Untied States.

For example, the rate of increase in personal consumption expenditures, which account for approximately 70 percent of the total output of goods and services in the U.S, has slowed substantially since March 2011.

While individuals and businesses alike did increase their borrowing during the first few months of 2011, and again during the first two months of this year, the rate of increase in those borrowings was substantially lower than during any other economic recovery since at least 1947, the earliest year for which data is readily available.

Meanwhile, the velocity of money - the number of times that the amount of money in circulation is used to purchase goods and services - declined during each of the past four quarters. That slowdown in the velocity of money indicates that low interest rates have failed to stimulate borrowing and spending in any meaningful way.

Because of the factors mentioned above, my experience suggests that the Fed will not implement a new round of quantitative easing - of purchasing huge amounts of U.S. Treasury securities - any time during at least the remainder of this year. Unlike many financial market strategists, I therefore expect the exchange-value of the U.S. dollar to continue to trend higher during the coming months and for gold prices to continue to trend lower during the weeks ahead.

In my next article, which I plan to issue within the next few days, I'll discuss why the same factors mentioned in this article, as well as some other factors and developments, suggest that inflation rates in the United States will not rise to any problematic levels for the foreseeable future.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I am short gold via the DB Gold Short ETN (DZG).