Will There Be a QE3?

Slowly but surely we step towards our day of reckoning. In just over a month, the Federal Reserve will end its bond buying program popularly known as QE2 or what many of us skeptics have likened it to, using a tiny band aid to qwell a huge hemorrhage. Depending on which side of the isle you stand, you may love or hate the Federal Reserve’s policy of quantitative easing.

Investors are certainly grateful to Bernanke and company for the near two year bull market, which has seen major market players (those that survived, that is)recover from the depths of the crisis. Many critics, however, have been vocal about the structural damage that the Fed’s debt expansion policies have done to the system long term. The question we face now is, will there be a QE3?

Though signs are point towards no one can never be too sure with Banana Ben and his Amazing Technicolor Printing Press. Here are three potential issues investors should watch for as QE2 winds down:

1) Offsetting Government Spending Cuts

The Fed’s intrusion into markets has lifted government spending to unheard of levels. The question remains whether private spending will pick up enough to compensate for the disappearance of government dollars in the overall equation. Combined with the overall sentiment of debt reduction present in the public, strange things could happen if private spending remains at the relative standstill it has been. On the bright side, American companies are flush with cash. Perhaps more so than ever before…

2) Keeping Rates Low

An end to quantitative easing suggests that interest rates will rise, because with the Fed out of the market for bonds, demand will fall, requiring issuers to pay higher rates to attract investors. To keep that from happening abruptly, the Fed has said it will continue to hold the nearly $2 trillion worth of bonds it has already purchased, instead of dumping them into the market and creating an oversupply of bonds.

Ouch. Anyone else see the inherent impossibility in this logic? Won’t bond traders simply wait the Fed out and create that notorious staredown effect which was present pre-crisis and led the Fed to get involved in the first place. How to keep rates rising at steady enough levels to boost growth and prevent some hyper/stagflationary scenario that the powers that be have been living in fear of for nearly three years? Hope some of you guys have good ideas about it, because I’m out of them and (admittedly) have been for quite a while.

3) Preventing a Debt Crisis

Though the article highlights that deficit management and cutting the huge national debt are not the Fed’s job, it has clearly become so by default (pun not intended). The weakened dollar blessed by the hocus pocus of quantitative easing has boosted American exports in the battle vs. China and other cheap labor emerging markets. This of course kills American’s purchasing power, which is an issue many amongst us are dealing with for the first time in our lives. How to reverse the weak-dollar machinery in the opposite direction would be easier said than done, if it weren’t difficult to put into words in the first place.
All in all, I remain both skeptical and nervous. The things that the Federal Reserve (in conjecture with the U.S. Treasury) now does on a regular basis require such tight precision, leaving so little room for error that the punting strategy will simply not work. Not because of some morally based appeal for sanity, but simply because all options (from the fiscal perspective) have been exhausted.

What do you guys see coming? Was QE2 the last straw? Will the Fed resort to another round if weaning us of the teet doesn’t work? What’s in store for the American economy? Can a comedy of errors among the high levels of our competition save us from our own incompetence? Or was perhaps…The Ben Bernank right all along…

For those who are more inclined to let a cartoon tell the tale, here’s another dose of what seems to be becoming our modern medicine for dealing with the hardships of reality. Maybe it really is this simple…time will tell, as with all else.