Tuesday, April 5, 2011

Life After QE2

“…it’s far from clear that the recovery will prove self-sustaining.”
Paul Krugman
NY Times, April 4, 2011

In his “The Transmission Mechanism for Quantitative Easing” commentary, Dr. Krugman delves into the how, why, and to what extent QE2 has worked thus far. He points to the sources of growth in US GDP (see accompanying chart) and highlights the fact that consumption and exports account for nearly 90% of the increase. Going a step further, Mr. Krugman then explores how a weaker US dollar and a higher stock market are likely significant factors to the results noting, “…casual observation suggests that a lot of the growth in consumer spending has been at the high end, which suggests in turn that a higher stock market might be driving it. And the lower dollar has clearly helped US exporters and import-competing firms.”

One conclusion from his analysis has to be the Fed’s intention of lifting the value of risky assets (stocks, specifically) and, thereby, triggering the “wealth effect” which then produces greater consumption which in turn helps the overall economy. However, as Mr. Krugman also notes, “…a lot of the growth in consumer spending has been at the high end…”, which helps bring him to a conclusion that is the crux of yesterday’s blog commentary: will the end of QE2 usher in an era of private sector led sustainable economic expansion?

If yes, then the US economy will (at best) continue to improve and maybe create the virtuous circle that enables the Fed and the government avoid, but more likely forestall, the day of economic reckoning.

If not, then what? Just a few points investors should contemplate as the stock market continues its Alfred E. Neuman (oh, excuse me, its climbing a wall of worry) rally.

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