It is NOT rocket science

QE2 is not rocket science, it is a lot more confusing than that. More and more people are coming out publicly against it. There are a myriad of arguments against it: likely to be ineffective, a scary opening of the inflationary Pandora's box, too many potential unintended consequences, a provocation for potential currency and trade wars, overstepping of the government's (at least, the Fed's) role to use public policy and funds to force investors into riskier asset allocations, deliberately weakened currency is bad and not a sign of strength ("Yes, I've used old 100 zloty notes to blow my nose as the bill was cheaper and softer than Kleenex and at the time the economy was very weak"). The argument in favor of QE2 seems to add up to increasing liquidity and the wealth effect (in a eerie echo of the "trickle down economics"). But liquidity does not seem to be a problem now, and the wealth effect impacts a relatively small portion of the population who are already busy shopping at Tiffany's to buy much more.

As this debate continues, it notable that many of people who have spoken out against QE2, were supporters of QE1. At the time of QE1, there was almost no market support for mortgages and the corporate bond market was in shambles. By stepping into a market which most people argued was cheap but in which they were too scared to invest their own money, the Fed created demand for mortgages and was thus able to get that market normalized. With Fed's lead, people who believed the mortgage market was priced irrationally gained the confidence to put on risk, and were rewarded for that.

QE2, on the other hand, seems to be pouring in money into a market that already seems bid without, By doing that the Fed is not solving a demand problem, and also potentially exacerbating the supply problem. If the curve was incredibly steep and everyone was piling into 1-month paper and avoiding 5-year, it would make sense, and sadly, some day we might be in that position, but for now with 5-year treasuries yielding under 1.25%, that is not an issue. Why does the government need to step in to buy more of what private investors are already buying?

Barron's touched on one of our favorite themes "the inability to rerun history without the intervention makes it hard to invalidate their self-serving claims." In spite of Helicopter Ben's extensive knowledge of the Great Depression, economics is not a "hard" science where every action has a clear attributable reaction. We can guess what the most likely outcomes might be, but there are just too many moving parts, and with people involved, not every action has the expected reaction. People do not always act rationally, and what might be actually rational for someone depends on so many factors that it is impossible to predict.

QE2 is here for now, but we hope that momentum against it is building sufficiently that it might never be fully implemented. Mr. Bernanke seems to be getting confident that he can manage the market's expectations. That scares us, because as soon as he is truly believes that he can manage the market's expectations, the market will not be managed that way. It is just not as easy as rocket science.