Hoisington Investment Management has been one of the few firms I track that has been absolutely dead right about QE2 since well before it began. Unlike most commentators who spent their time fearing about hyperinflation, “money printing”, debt monetization, etc. Hoisington actually focused on the transmission mechanisms and the actual realities of the monetary operations at work. They clearly explained how more reserves would not result in exploding inflation, growth or anything of real benefit. With GDP revisions now coming in at a furious downward pace for Q1 it looks like they were exactly right. In their latest missive they describe why QE2 has failed to help the economy:
“If the objectives of Quantitative Easing 2 (QE2) were to: a) raise interest rates; b) slow economic growth; c) encourage speculation, and d) eviscerate the standard of living of the average American family, then it has been enormously successful. Clearly, with the beneft of 20/20 hindsight these results represent the Federal Reserve’s impact on the U.S. economy, regardless of their claims to the contrary.”
They go on to discuss all of the facts that the Federal Reserve prefers to ignore: declining wages, declining GDP, declining home prices, surging interest rates, surging commodity prices, and the surging equity markets (that only really help the top income earners in America).
The more interesting portion of the commentary is their outlook going forward and the end of QE:
“The historical record on massive Federal Reserve intervention is minimal but indicates that as QE2 terminates at its scheduled end on June 30th, the inflation/risk trade will also fade. Accordingly investors should gradually move into Treasury securities and other high-grade risk adverse investments. This will release funds for the mortgage market and credit worthy state and local governments. Upward pressure on commodity prices will abate. This will begin to mitigate the downward pressure on real wage income and consumer confidence. The lower commodity prices will also serve to unwind the corporate margin squeeze that resulted from the higher commodity costs.
While the economy will slow initially, the drop in inflation over time should lift real income and serve to stabilize the economy. The dollar should firm, encouraging foreign investors to place additional funds in U.S. markets. Taken together, these factors should give the economy the opportunity to stand on its own, rather than rely on massive governmental interventions whose potentially negative and unintended consequences are unknown.
The evidence of the past three years seems clear in that monetary and fiscal policy have been unable to improve the average American’s standard of living. Time will be required to reestablish balance sheets to more normal levels, and in the interim disinflationary/deflationary tendencies will be ascendant. This environment is favorable for holders of long dated Treasuries. Positioning for an inflation boom will prove to be disappointing.”
Excellent summary. I’ll have my thoughts on the end of QE2 early next week.
Source: Hoisington Investment Management
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.