As of June 30th, the US Federal Reserve officially ended its quantitative easing program. Dubbed QE2, the Fed made US$ 600 bn of purchases of bonds, and this is now set to end. This was a follow on to their previous quantitative easing policy. A close study of the Fed's recent comments indicates that the QE policy is likely to end, for now at least.
The QE policy was controversial from the start. The QE policy amounts to printing money to buy government bonds, and effectively allowing the US treasury to continue to borrow long term at very low rates. It was designed to bring down long term interest rates to stimulate the US economy, after short term rates had already been brought close to zero.
Criticism of the policy came domestically within the US, and even more so internationally by countries holding large US$ reserves. Within the US, it was criticized for having the potential to significantly increase inflation. Internationally, the primary concern was that the dollar would devalue. And countries (especially China) that held significant dollar reserves would suffer. Many countries were also concerned that it would lead to increased capital flows as investors would look to move away from a depreciating US currency.
So what is the verdict on quantitative easing? From a US point of view, it has been mixed. So far, there has not been any significant rise in inflation as many were predicting - but this could change as the effects of the policy won't be fully known for some time.
On the plus side it seems to have done its job of keeping interest rates low, and has generally been good for stock markets. Economically, it is less clear. The US economy is growing, but slowly, and unemployment remains high. It certainly has not had the impact policy makers were looking for, but it has not been a disaster either.
From an international perspective, some of the concerns have turned out to be true. First, the dollar has devalued considerably against many of its international trading partners in the last year (even the battered euro). Second, due to this this devaluation, dollar reserves have fallen in value.
One of the unintended consequences of QE has been a boom in commodity prices. Though QE has not triggered high inflation, it certainly triggered the fear of high inflation. This led investors to pile heavily into commodities, especially gold and silver. The excess cash created by QE seems to have mostly found its way into higher commodity prices.
It's not just gold and silver. Crude oil has gone up significantly, as have many agricultural commodities. Inflation due to rising commodity prices does appear to be taking place around the world. The higher commodity price factor appears to be one of the main reasons the Fed is not planning to extend this policy. The QE policy did little to help the US economy (even if it did not do much damage), but it certainly is not worth the risk of higher food and energy prices.
Asad is an Economics Graduate from The London School of Economics who has also been a part of the currency derivatives team of Deutsche Bank in London. Currently pursuing his PhD at the University of California San Diego where he's researching on Algorithmic Trading Strategies, Asad will be your direct line for answers to all the questions you might have on short-term investing. A part of the Equitymaster Team since 2010, Asad has been sharing his knowledge on short term trading strategies with our valued readers, like you, through our various services. In fact, at the last count, his weekly newsletter, Profit Hunter, was being delivered to more than 100,000 smart traders across the world!