Federal Reserve: Quantitative Easing 2 Is A Dangerous Game
The Dynamic Wealth Report
November 5, 2010
by Robert Morris, Editor
In the classic 1955 film, Rebel Without A Cause, 17-year old Jim
Stark (played by James Dean) is pressured into playing a high-stakes
game to resolve a dispute with school bully, Buzz Gunderson (played by
Corey Allen). After Jim triumphs over Buzz in a knife fight, Buzz tries
to regain his pride by challenging Jim to a “Chickie Run”.
A Chickie Run involves the two boys racing stolen cars towards an abyss.
The one who jumps out of the car first is deemed a “chicken” or coward.
Apparently, being called a chicken in 1955 was a tremendous insult.
However, the game ends in tragedy when a strap on Buzz’s leather jacket
gets caught on the car door. Unable to jump out of the car, Buzz goes
over the cliff to his doom.
At least he wasn’t a chicken!
Certain events this week reminded me of James Dean’s famous Chickie Run. Of course, I’m referring to the much talked about second round of Fed
quantitative easing.
Also known as QE2.
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For weeks, investors have been speculating about what the Fed is going
to do with monetary policy given the sluggish economic recovery. With
interest rates already at near-zero, the Fed’s most basic tool – raising
or lowering short-term interest rates – was no longer useful.
This left the Fed’s next favorite weapon – quantitative easing – as the
only viable option. Quantitative easing is a fancy economic term
describing the Fed’s practice of printing dollars to buy U.S. Treasury
debt. And it’s a very dangerous move to make.
Here’s how it works…
By buying Treasuries, the Fed injects dollars (or liquidity) into the
monetary system while simultaneously reducing the supply of Treasury
debt. The net effect is more money for banks to create lending and a
depressing of yields paid on Treasuries.
The belief is quantitative easing will stimulate banks to lend out more
money and make it cheaper for companies to raise capital. Companies will
then use this capital to grow their businesses. And ultimately the
nation’s rate of economic growth will increase significantly.
Sounds great right?
The only problem is there’s a huge potential downside risk…
The policy could be more effective than intended.
If the Fed injects too many dollars or continues the policy for too
long, it could spark hyperinflation – very high or out of control
inflation. Hyperinflation usually leads to severe economic depressions.
In periods of hyperinflation, prices of ordinary goods and services rise
5%, 10%, or more every day! Can you imagine what would happen if prices
of food and gas were doubling every two to three weeks?
Despite this astonishing risk, the Fed announced this week a second
round of quantitative easing.
They’re going to buy $600 billion more of Treasury debt. What makes this
a risky bet is it comes after a huge buying spree in 2009. Last year,
the Fed bought $300 billion of Treasury debt, $150 billion of Fannie Mae
and Freddie Mac debt, and $1.1 trillion of mortgage backed securities.
As you can see, the Fed has already injected a huge amount of money into
the system. If QE2 is not handled properly, it could very well spark
runaway inflation and send our economy into a nasty downward spiral.
Like the “Chickie Run”, the key to quantitative easing is the exit. If
the Fed waits too long, we’ll all end up going over the cliff together.
• Towerstream (TWER) was
upgraded by Morgan Joseph from Hold to Buy. The wireless internet
service provider just raised fourth quarter revenue guidance above
analysts’ estimates. The analyst’s price target of $4.75 implies upside
potential of over 40%.
• Keybanc Capital Markets downgraded Red Robin Gourmet Burgers (RRGB)
from Buy to Hold. The restaurant chain’s third quarter numbers missed by
a mile and management suspended 2010 guidance. The shares are plunging
on the news.
• Collins Stewart began coverage on several medical device companies.
They’ve started both Boston Scientific (BSX) and
St. Jude Medical (STJ)
with a Buy rating and Medtronic (MDT) with a Hold. They’re clearly
viewing the Republican takeover of the House as a positive for the
industry.
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