Jonathan Bishoff's  Instablog

I could take the time to include some graphs of the S&P relative to annoucements of QE and so forth to try and conclude that no-one can say either way if QE is working or not.  BUT thats entirely unneeded and probably unwarranted.

Economists are famous for always having the right answers....allbeit with the right assumptions.  The Fed is acting under one primary assumption when choosing to implement a QE scheme.  That assumption you ask?  Is that a productive use for capital exists but that no excess capital is available.  Translated for simplicity:  The Fed believes productive business opportunities exist and that businesses need cash to pursue them.  This assumption could not be further from the truth.  Global equity is estimated north of $50 trillion.....give or take a trillion here, trillion there...the point is that capital exists in the market, its just not being loaned to businesses as the creditors are not willing to take the risks given the extremely low yields.  So whats a Fed to do?  Make the yields even lower by buying treasuries.  This of course puts liquidity into the market and theoretically should tick up inflation and lower unemployment (think of the Phillips Curve...).  But it will not have that effect.... why?  Because there is one assumption being avoided by the central bank....

THERE IS NO NEW DEMAND FROM CONSUMERS.  That is the big answer to why QE does not work.  It has nothing to do with economic theory (as I am sure the MIT educated economist knows more than all other men combined).  It has to do with productive capital projects.  Think of it this way:  JP Morgan does not need $5bb to loan to XYZ shoe company to build a new factory...why?  Because XYZ shoe company does not need to build a new factory even if the loan comes with a low interest rate because they are currently supplying the requried demand.  No new demand means no need for additional supply.  Some of you are already thinking....what about the wealth effect??  Give me a break.  The average person has an exteremly low understanding of purchasing power and the probabilty of rising inflation.  Scarying people of inflation will not cause them to spend money they dont have. However businesses do and thus will be raising prices down the road to ride the wave.  The average consumer will be left with their pants off confused as to why everything around them is getting more expensive. 

So where does this take us?  That QE 2 (and for that QE 3, 4, 5 and 6) have no need unless demand is not being supplied.  Create demand and you will see supply resources needed (property, loans, etc.).  Not to mention that monetary velocity is needed to move cash quickly through individual firms....not give it to primary dealers who then loan it back to the Fed....