"And for His Next Trick...QE3!"

The latest news on the economic front.

The U.S. economy struggles. For the last few years the Federal Reserve has tried to stimulate the economy by cutting interest rates. The rates have been cut so low, they can't be cut anymore. This is call “zero bound.” The chairman, Ben Bernenke, initiated a new plan. Once it was revealed to the public, it created the stock market to jump to a 13-month high. It is being called the “Bernanke bounce.”

This bold new plan could be referred to as QE3 or the central bank’s version of a stimulus. The Fed will continue to pump $40 Billion into the economy each month until the job market improves. This method is called quantitative easing and has been implemented twice in Obama’s term - QE1 & QE2.

Unlike Europe who has been focused on austerity (more or less cut overspending), the Obama administration has pushed for a stimulus (more or less go into debt to encourage spending).

As much as Obama has tried, congress has not been cooperative. So when the Fed announced they were to do their own version of the stimulus, and since Obama can’t make decisions for the Federal Reserve, he must have breathed a heaving a sigh of relief at the news.

How it works.

The Fed will accomplish this QE3 by essentially printing money when it buys bonds or other securities on the open market (with hopes that inflation won’t rise). Unfortunately, past episodes of temporary infusions of cash by the central bank have yielded little results. The difference with this plan is that the Fed wants to keep it going for “as long as it takes,” said Bernenke The Fed has already bought over 2 trillion in government and housing debt in QE1; QE2 and is expected to spend over a trillion more on this plan. But will it work? That’s the 40 billion dollar per month question.

Stock Market

Wall Street loves it, since it drives down interest rates and lures investors out of safe investments like treasury securities, and into riskier investments such as stocks. Rising stock prices draw more buyers off the sidelines, boost sales commissions at brokerages, and generate more investment banking activity.

Main Street

Will this help the common U.S. citizen? 

Americans can also look forward to as Bernenke put it “more demand for homes and more refinancing” by “putting downward pressure on mortgage rates. “ Experts believe a drop of .25% may occur. So a 3.25% 30 year loan would drop to 3.0%. Therefore, those who own homes may feel better knowing the value of their homes will go up.

Nevertheless, most Americans could care less about the value of their home when they are concentrated on keeping their home from foreclosure. And, even with record rates not seen since the great depression, it becomes a risky venture to buy a home in an unstable job market. Even Bernenke said, “the weak job market should concern every American.” Ya think?

The real proof the QE3 will work is if more jobs are created.

But don’t hold your breath. QE1 and QE2 haven’t brought unemployment numbers down, so it's unwise to expect the QE3 come to the rescue…see idioms below:

            QE1 You can lead a horse to water but you can’t make him drink.

            QE2 You can lead a horse to more water and he still may not drink.

            QE3 You can keep leading the horse to lots of water month after month and prodding him to take in the clean, blue, cool, fresh elixir, but you still can’t make him drink.

Bottom line – Jobs are the true sign of recovery.

When Wall Street succeeds and employment suffers, it is called a jobless recovery. Anytime unemployment is high, there is no real recovery. 

So how do we get more jobs? People get jobs from companies that need workers. It’s that simple. So why aren't companies hiring? Some think companies hire workers when tax rates are reasonably low, but past data doesn't prove this out. Additionally, low interest rates intended to get companies to hire, also do not prove true. In short, companies will hire workers when they predict that job orders will exceed the current work staff. Companies must feel confident future business will occur.

QE3 and Jobs:

So how will pumping Fed money into the economy provide jobs? It doesn’t. But what it does do is prime the pump so that something can occur. And this something translates into confidence. Bernanke is hoping that confidence will build from his QE3 and activity will occur in the job market. Companies will catch the bug and hire the unemployed, and eventually unemployment will drop below 7% or so. The economy will then be on stronger footing and…. Voilà! Happy days are here again.

QE3 and reality:

Bernenke sees a connection between mortgages and business hiring – I believe it is only one piece of the puzzle and do not have high expectations.

First, people are practical. If a business person sees nothing but uncertainty in the industry, looming heavy regulatory laws, and potential tax increases that may reduce profits, why would he/she invest in something new like a piece of machinery or a worker?

Second, we can’t be myopic. The U.S. does not operate in a bubble. Europe is still going through its own economic woes. This whole thing may actually backfire if Europe gets nervous about the Fed’s frivolous spending spree. The U.S. can’t sell if Europe doesn’t want to buy. And this is only Europe. China (who is now going through a tough spell of its own), Brazil, and other countries are no doubt watching too. The U.S. economy is inextricably attached to the world market and it can only move forward if the rest of the world is confident as well.  

The Fed is essentially out of tricks and is hoping this last one will work. And only time will tell whether or not Bernenke has pulled a rabbit out of his hat or whether he is only talking through it.