01/14/2011 01:02 pm ET Updated May 25, 2011

The Good, the Bad and the Ugly of Quantitative Easing

"Where did you dig him up?" asks a HuffPost reader in Houston, who criticized a piece I did last week quoting an economist who predicted slow economic growth and a mediocre stock market in 2011. In an e-mail, the reader wrote,

Has your Rip Van Winkle economist ever heard of quantitative easing? Why not wake the guy up and tell him how eminently successful it has been both for the economy and the stock market. Also, what's to stop the Federal Reserve from giving us another shot in the arm through QE 3, 4, 5, or even QE 10, if necessary? Tell your guy the Fed is doing the right thing and that we're on a QE roll.

Actually, it wasn't a guy, but a gal, and a pretty sharp one at that. The reader's criticism was directed at Madeline Schnapp, the economic chief of West Coast liquidity tracker TrimTabs Research, which is partially owned by Goldman Sachs.

In response, Schnapp, who takes issue with the reader, argues that quantitative easing--an action designed to boost asset values, lower interest rates and pep up the economy--is hardly the panacea it's cracked up to be. And she stressed this in a recent commentary she fired off to clients, which, in effect, zeroed in on the good, the bad and the ugly of QE.

First to the good. Based on the performance of the S&P 500, QE1 and QE2 have been big winners. In QE1, the Fed bought $1.25 trillion in mortgage-backed securities, $300 billion in U.S. Treasuries and $200 billion in agency debt from March 2009 through March 2010. As QE1 was implemented, the S&P 500 ballooned 67%. Then the economy lost momentum from April 2010 through August 2010, and the index fell 13%. Since Ben Bernanke announced QE2 in August of last year, the S&P 500 has risen more than 20%.

Next, the bad. While the Fed's bond buying--which stretched its balance sheet--has boosted economic growth, the major beneficiaries, notes Schnapp, have been stock market investors and financial companies, not Main Street. In turn, she points out, quantitative easing has left the structural problems of the economy untouched, including a depressed housing market, burdened with the prospects of another 10% to 20% decline in prices, enormous state and local government budget shortfalls, rising energy prices, a battered consumer population that has $1.1 trillion less to spend than it did in 2008, and the huge budget deficits that leave the U.S. vulnerable to the generosity of foreign investors.

Unless these structural problems are addressed, Schnapp says, "the economy will grow slowly and depend heavily on government largesse."

As she sees it, so far, at least, the impact of QE on both economic growth and employment has been anemic at best. For example, GDP growth was a modest 2.7% in the third quarter of 2010. Further, employment increased an average 94,000 jobs per month last year, considerably less than the monthly 150,000 average necessary to absorb population growth. Likewise, the after-tax income of all U.S. taxpayers rose only $40 billion in 2010, and that was down more than $500 billion from the 2008 peak.

She also hastens to point out that given the fact wage and salary growth is likely to remain in the 3% to 5% range over the next year, contributing only $200-$300 billion to consumer spendables, and equity extracted from real estate will only amount to a paltry $600 billion, nearly 93% below its housing bubble peak, it is unlikely the consumer will be able to contribute anywhere near the amount of money needed to goose the economy into high growth mode over the near term.

Finally, the ugly. Since QE2 is inflationary, the real danger exists, says Schnapp, of a possible rebellion from China, Russia, Japan and oil producers, which could get fed up with the devaluation of our currency. Longer term, the risks could be immense, she says, "At some point, we may not be able to sell our Treasuries."

Money is a store of wealth, Schnapp observes; if it's simply printed rather than created via a productive activity, then the store of wealth is devalued. "Eventually, there will be a day of reckoning because we're spending way beyond our means, and at some point we'll have to pay the piper."

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