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Matthew Cowie
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Financial Analyst for Mutual Fund Investor Guide; currently living in Beijing, China. Previously worked as a financial analyst for for Fidelity Independent Adviser Dion Money Management. Articles written for FIA and DMM appeared on, Yahoo Finance, and Seeking Alpha.
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Mutual Fund Investor Guide
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Investing in Chinese Stocks
  • Why QE3 Will Fail 0 comments
    Sep 17, 2012 5:05 AM | about stocks: GLD, SPY, GDX, GDXJ, SIL, SLV

    This article is neither intended as support or a critique of quantitative easing policy in general. My argument here is only that it will fail due to its small size, just as the D-Day invasion of Normandy would have failed if it consisted of one army division.

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    Excessive Debt Total credit in the United States is about $55 trillion: The private sector has debt of almost $40 trillion, while state, local and federal government combine for more than $14 trillion (this figure uses the federal public debt number, not the $16 trillion figure that includes intragovernmental debt). Even if there was no federal debt, private sector debt (consumer debt, mortgages, banking sector debt, etc.) is unsustainable at roughly 250% of GDP and requires deleveraging.

    The private sector began deleveraging in 2008, as the third chart shows. Debt is being destroyed, either through repayment or default―a lot was defaulted on by banks in 2008. Many homeowners defaulted on their mortgages or credit card debt. Since 2009, much of the deleveraging has happened because people slowly repay their debt over time (each monthly mortgage payment is for interest and principal) and they have not been taking out new debt.

    In contrast, federal deficit spending has offset the deleveraging in the private sector, helping push total credit market debt up about $1 trillion since 2008, to $54.6 trillion. If the federal government did not offset this deleveraging, economic growth would have been negative over this period.

    Put another way, the bulk of the deleveraging took place in 2008 and 2009―the crisis―and this was stopped by massive federal government and Federal Reserve intervention. The financial sector still needs to repay or default on trillions upon trillions in debt and that's why the risk of a crash is constantly in the background―if it happens in a "disorderly" manner, we get 2008 again.

    Why QE3 will fail: it isn't big enough

    The economy is going to return to a position where total credit is a much smaller multiple of M2 (and GDP and M1). To return to the ratio of credit/M2 seen at the start of the 1980s, the U.S. needs to deleverage to the tune of $25 trillion or M2 needs to increase by $8 trillion. (See fourth chart above) At the current pace of M2 growth, that will take between 10 and 15 years, assuming no recessions or deflationary periods that cut credit growth.

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    If the U.S. were to experience a Japan scenario where nominal GDP growth is 0% after 20 years and the federal government offsets private sector deleveraging, the Federal Reserve may well be running QE3 into the 2030s.

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    These figures are not hard estimates, but they do portray the depth of the crisis. I don't have an exact figure for a QE that would cause inflation to spike up and stay up, but it is definitely in the multiple trillions of dollars, or hundreds of billions per month, far larger than the announced policy.


    The U.S. is in a debt crisis. This crisis exploded in 2008 and was relatively quickly halted by federal government and Federal Reserve emergency policies. In the ensuing years, the U.S federal government ran large fiscal deficits and the Federal Reserve engaged in various policies designed to stimulate the economy. The result has been stasis at a lower level of economic activity, with consistently high unemployment.

    The impact of QE3 will be a short-term bounce in financial markets and commodities, a portion of which was anticipated by investors ahead of the QE3 announcement. When QE3 fails, the Federal Reserve will announce an increase in the amount of debt purchases or the economy will sink into recession, with very negative results for the financial and commodity markets. That said, while deflation is the overriding concern today, investors should be hedged with precious metals.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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