Think Quantitative Easing is Good for the U.S. Economy? Here Are 6 Indicators That Say Otherwise.

By Mohamed Assed - August 8, 2012 | Tickers: DBC, UUP, SPY, UGA | 0 Comments

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Introduction

Judging whether Quantitative Easing (QE) was successful or not in reviving the U.S Economy is too broad a statement to be of any usefulness. The scope of such a topic impedes 100% sure findings and conclusions. On this basis, this article will attempt to look into the efficacy of QE in stimulating the U.S Economy from its own standpoint by making use of a simple yet intriguingly revealing set of facts.

This article will evaluate the efficacy of QE in reinvigorating the battered U.S Economy from its very own inclined standpoint. This may hinder many pieces of the puzzle. In other words, as with any other social science topic or research, this article is by no means a 100% complete and perfect presentation of the efficacy of QE in reviving the U.S Economy. The article presents, in its own way and direction, a fruitful and reliable set of findings and conclusions.

What is Quantitative Easing?

Quantitative Easing (QE) is a more sophisticated way of saying that a central bank is printing money. However, rather than financing its deficit, the central bank would presumably stimulate the Economy by buying treasury securities from the secondary market. The Federal Reserve System of the United States of America (Fed) has been adopting the policy of lowering the federal funds rate, and buying treasury securities. The policy was aimed at reinvigorating the battered U.S Economy after the financial crisis of 2008. This article will evaluate the success of QE by looking at the effect of QE on the inflation rate, the purchasing power of U.S citizens, the prices of oil and commodities, and the dollar value (by making use of the PowerShares DB US Dollar Index). In addition, we will also emphasize to what extent was QE successful in lessening unemployment rates.

On the 25th of November 2008, The Federal Reserve announced its first round of quantitative easing in an aggressive response to save the U.S Economy from further tumbling. The U.S.A is at the heart of the World Economy and is the strongest Economic Empire in the world. It consumes roughly 25% of the world's energy resources, and holds the largest gold reserves. In addition, all energy resources and commodities are traded in international markets using the U.S Dollar, so the U.S Dollar acts as the world's reserve currency. On this basis, whatever happens to the world reserve currency will necessarily affect the shape of the world Economy to a large extent. Recently, there has been a lot of hype in the media concerning the Fed's plans to rescue the U.S Economy by expanding the monetary supply, lowering interest rates and buying treasury securities. QE spurred a lot of debate among economists as to its success versus its failure (or more precisely damage to the U.S Economy as a whole). The above mentioned reasons are the points that fuel this article's intent to dig into the much debatable plan of the Fed, Quantitative Easing.

Problem Statement

"Saving the U.S Economy" is too broad an explanation of the Fed's specific objectives. Essentially, the Fed's unconventional monetary policy first aimed at lowering the federal funds rate to the zero range in order to encourage lending among commercial banks. These latter set of actions ought to form the core over which the whole recovery process was built. The Fed's actions to cut the Federal funds rate to a 0%-0.25% rate were not for the sake of solely infusing banks with cash. The idea was that banks would massively help in the recovery of the U.S Economy by lending more money to U.S households, corporations, and small businesses. However, banks had a hard time trusting that credit holders would not default once again on their principal and interest payments causing a much unwanted reminiscence of the subprime crisis in 2008.

The reason why quantitative easing has triggered so much debate and hype among economists and the media alike is the risk inherent in such a program. Several renowned economists, investors and politicians have made it clear that the Fed's aggressive actions of stimulating are not deemed necessary to say the least. According to highly coveted Republican senator Ron Paul (2002), "a system of capitalism presumes sound money, not fiat money manipulated by a central bank. Capitalism cherishes voluntary contracts and interest rates that are determined by savings, not credit creation by a central bank." Self-made billionaire investor Warren Buffett (2011) was quoted saying, "I don't think we need as much either monetary or fiscal stimulus as is going on. I think we needed -- the American public, the whole world -- needed to see two years ago that the federal government when the world was going to try and deleverage and people were panicked over every kind of financial instrument, they needed to see the federal government there big time, and the government really did its job there in the fall of 2008. I have enormous respect for Ben Bernanke. He knows way more about the Fed than I do by a factor of 100 to one. But in the end, I don't think we need more of that (quantitative easing) now."

However, Pro-quantitative easing adverts would probably point to the significant rally in stock prices caused by the Fed's "unconventional" monetary stimulus. Nonetheless, such a stimulus can only come at a price. In other words, the stock market became more volatile and unstable, and thus many individual investors refused to commit their money in the stock market. They would rather invest based on solid business factors. Said differently, if stocks go up because the Fed is printing money is not beneficial as if the stocks go up because the Economy is doing better. Thus the risks posed by QE are as follows: damaging the value of the U.S Dollar and increasing the rate of inflation. Adding to the non-QE-policy camp is Nassim Taleb. The Oxford University Professor stated (2010), "The Fed does not understand risk."

Furthermore, the solution to a housing bubble is not another housing bubble. Moreover, Quantitative Easing threatens the status of the U.S Dollar as the world's reserve currency. Bestowing to Peter Schiff's statement (2011), "the clock is ticking until the dollar faces a crisis of confidence like every other bubble before it. The key difference between this collapse and, say, the bursting of the housing bubble is that the US dollar is the backbone of the global economy. Its conflagration will leave a vacuum that needs to be filled."

According to Bernanke (2010), "The Federal Open Market Committee (FOMC) will strongly resist deviations from price stability in the downward direction. In other words, the FOMC under the Fed's authority expanded the monetary supply to fight deflation." Nevertheless, the deflation claims of the chairman of the board of governors of the Federal Reserve System of the United States of America will be evaluated in this article by having a look at gas prices, tuition costs, stock prices, and commodity prices before 2010 (i.e. before Benshalom Bernanke's remarks on "fighting deflation").

6 Ironclad Indicators That Suggest QE Has Been More of a Failure Than A Success

1st Indicator: Gasoline Prices

The relationship between monetary policy and oil prices is empirically supported. Noureddine Krichene and Researchers at the International Monetary Fund (IMF) (2006) found that the high oil prices in 2004-05 could be explained by an "excessively expansionary [U.S.] monetary policy, with interest rates falling to record levels in an integrated international capital market. Stimulated by low interest rates and a depreciating U.S. dollar, demand for oil has expanded faster than supply."

We will make use of the United States Gasoline Fund Price (NYSEMKT: UGA) to see whether gasoline prices were showing a deflationary spiral.

Figure 1

Comment on figure 1: We can see from figure 1 that gasoline prices do not show any kind of deflationary spiral from the periods of 2010 and onwards. Ben Bernanke (2010), the chairman of the Fed, announced that "The Federal Open Market Committee (FOMC) will strongly resist deviations from price stability in the downward direction. In other words, the FOMC under the Fed's authority expanded the monetary supply to fight deflation." However, figure 1 presents a factual evidence that states the following: Gasoline Prices may well have been decreasing in the United States since the financial crisis hit, but the deflationary spiral that started with the beginning of the third quarter of 2008 was put to an end when the Fed announced the first round of quantitative easing on November 2008 (i.e. during the first month of the fourth quarter of 2008). When the first round of quantitative easing took effect in the U.S Economy, a significant increase in gasoline prices took place all around the States. Indeed, the increase in gasoline prices in the United States has been mounting throughout all of 2010 due to QE. And by referring to Bernanke's comments regarding "fighting deflation," one can hardly notice any deflationary trend in the prices of gasoline in 2010 as reported by the average price of the United States Gasoline Fund. Accordingly, Bernanke's claims regarding the fight of deflation seem to be out of topic from an analysis of oil and gasoline prices. On the contrary, Americans' purchasing power has been suffering since the release of QE from huge increases in gasoline prices. Furthermore, additional considerations regarding the implementation of a third round of quantitative easing has rolled in more debate than concurrence among Economists, and has spurred more rebellion than resentment among many classes of the American society.

2nd Indicator: Tuition Costs of Colleges and Universities

The second factor that seeks to show whether deflation is threatening the U.S Economy is Tuition Costs. To measure tuition costs, this article will make use of the average annual tuition costs of Colleges and Universities during the last decade.

Figure 2

Comment on figure 2: We can see from figure 2 that there was no kind of deflation in the tuition costs of Colleges and Universities. On the contrary, tuition costs have been increasing greatly. Even after the financial crisis, when the major sectors in the U.S Economy suffered a major decrease in prices, Colleges and Universities showed no signs of retreat in terms of tuition costs.

3rd Indicator: Stock Prices

The third factor that seeks to show whether deflation is threatening the U.S Economy is the general price of stocks. To measure the general price of stocks, this article will make use of the SPDR S&P 500 ETF (NYSEMKT:SPY) to show the general tendency of stock prices in relation to the announcement of the first and second rounds of quantitative easing.

Figure 3

Comment on figure 3: As shown in figure 3, when the first round of quantitative easing was announced, the stock market experienced a huge rally in prices from January 2009 onwards. The rally was further fueled by a second round of quantitative easing during the first quarter of 2011. Recent talks of a third round of quantitative easing rendered the stock market more bullish and scared off the significant drops in the Dow Jones Industrial Average in the second quarter of 2012 due to the shattered Economic situation in Europe. Deflation was certainly not taking place during 2009, two whole years before the implementation of the second round of quantitative easing.

4th Indicator: Commodity Prices

The fourth factor that seeks to show whether deflation is threatening the U.S Economy is the general price of commodities. To measure the general price of commodities, this article will make use of the PowerShares DB Commodity Tracking Index Fund (NYSEMKT:DBC) in relation to the announcement of the first and second rounds of quantitative easing.

Figure 4

Comment on figure 4: Figure 4 shows the increase in commodity prices in the United States after the announcement of the first round of quantitative easing much in the same way that prices of stocks and gasoline showed increased momentum after the announcement of QE on the 25th of November, 2008. Obviously, there was no sign of deflation in commodity prices, presenting yet another factor that contradicts Ben Bernanke's comments regarding "fighting deflation."

Second, this article will have a thorough look at the effects of QE on the purchasing power of the U.S Dollar. As more and more money circulates the U.S Economy, intuitively, the purchasing power of the U.S Dollar will have to decrease. However, we will make use of reliable tracking indexes to see whether there is empirical evidence that supports the decrease of the U.S Dollar value because of the announcement and implementation of QE.

5th Indicator: Effects of QE on the purchasing power of the U.S Dollar

The effects of QE on the purchasing power of the U.S Dollar will be measured by making use of the PowerShares DB US Dollar Index Bullish (NYSEMKT:UUP).

Third, we will measure the efficacy of QE by having a look at the unemployment levels after the announcement of QE. The article would later on compare the actual unemployment figures to the projected figures by the Fed. Significant failure to reach the goals of a certain number of job creations through QE, would give us a more confident set of findings and conclusions as to the success or failure of QE in bracing the U.S Economy.

Figure 5

Comment on figure 5: We can see from figure 5 that the U.S Dollar knew a significant drop in its value after the announcement of QE. Until the 1st of June 2012, the dollar dropped 11.26% in its value after the Fed announced the first round of quantitative easing in the month of November.

6th Indicator: Effect of QE on unemployment levels

To show how successful QE was in reducing unemployment levels, this article will make use of the actual official job creation figures to the projected figures to be created by the Fed. Unemployment rate data will be retrieved from the official website of the U.S Bureau of Labor and Statistics.

Comment on figure 6: As figure 6 obviously shows, the unemployment rate kept creeping its way up since the announcement of the first round of QE in November 2008 until November of 2009. From November 2009 until November 2010, the unemployment rate remained constant and unchanged. Unemployment levels in the States as depicted by figure 6 decreased by a mere percentage digit during the second round of QE.

Conclusion

This article showed whether QE was successful in reviving the U.S Economy by emphasizing the effects of QE on gasoline prices, stock prices and commodity prices. It has found the following revealing facts and results, the bloating of the Fed's balance sheet has contributed to an almost 12% decline in the value of the dollar versus a basket of other currencies from November 2008 till May 2012; additionally, QE programs seem to have, at the very least, contributed to the sharp increases in commodity prices; moreover, QE has been very kind to stock investors, and stocks performed far better during periods of QE support as compared to during periods which the Fed had withdrawn its QE support.

This study has also revealed whether QE was successful in significantly lessening the unemployment rates in the United States. According to figure 6, QE failed to significantly lessen the unemployment rate in the United States.

We conclude, from the previously shown findings that quantitative easing was not successful in significantly lessening the unemployment rate, strengthening the U.S Dollar value, and lowering the prices of goods and services, and commodities. If those aren't enough indicators to tell whether QE was successful or not, I don't know what are.

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