Analysis: QE3 may do more harm than good

There may be a point at which global investors get indigestion from U.S. money printing.

A fresh round of U.S. monetary easing may even do more harm than good for long-term investors as another flood of easy money into fast-growing emerging economies risks refueling oil and commodity price inflation, sapping consumption and growth.

Prospects for a third round of the Federal Reserve's quantitative easing program (QE3) grew this month after Chairman Ben Bernanke said the central bank was prepared to ease further if economic growth and inflation falter again.

Nearly in one in two fund managers surveyed by Bank of America Merrill Lynch this month said QE3 was likely.

The temptation for risk-loving investors is to rub their hands with glee. Traditionally risky or high-yielding assets such as global equities, energy and commodities and emerging markets surged in the months after the Fed gave the green light for Round Two of QE -- which involved $600 billion in new money in the form of Treasury debt purchases and which ended last month.

But the impact on the U.S. economy and the labor market has been less obvious, given that growth has slowed significantly into 2011 -- at least partly because higher energy costs have undermined consumer spending everywhere. Asset prices, as a result, have retreated sharply again since April's peaks.

This has given rise to a debate about whether QE3 works. If it doesn't give a sustained boost to financial markets and is ambiguous for the real economy, is there any point?

"We have a negative opinion of QE2, and believe QE3 could very well turn out to be ineffective at best, and counter-productive at worst," said Stephen Jen, managing partner of London-based hedge fund SLJ Partners.

"If we are right, QE will be self-defeating in that the more the Fed eases, the more commodity prices rise, which erodes the capacity of consumers to spend on non-energy products and services."

Since Bernanke unveiled the Fed's QE2 bond buying program in a speech in Jackson Hole in August last year, Brent crude oil have risen 58 percent, while the benchmark CRB commodities index has gained nearly 30 percent.
Developed and emerging stock indexes are both up around 20 percent since that speech but they are coming off their April highs. On the year both of them are largely flat.

"My best guess is that there will be a few weeks of positive reaction, followed by a sell-off, as investors realize the circular and pointless logic of (the argument that) QE2 could lead to permanent increases in economic activities," Jen said.

UNINTENDED CONSEQUENCES

Some advocates say quantitative easing works best by revaluing financial assets so that there will be a positive wealth effect for U.S. consumers, encouraging them to start spending again. The Fed argues that it boosts credit in a similar way to an orthodox easing by directly lowering long-term benchmark borrowing costs.More...