How much pain will Bernanke allow before going for QE3?

Posted on 08 June 2011 with 10 comments from readers

Financial markets and even bullion sold off again in the wake of Fed chairman Ben Bernanke’s downbeat comments on the US economy last night with not a hint of a possible QE3 money printing exercise to stimulate the economy.

The reasonable fear in markets is that the ‘Bernanke put’ is over, and that without the Fed as the buyer of last resort financial markets will crumble. Then again you could argue why would you expect a QE3 to be any more effective than a QE2.

QE2 boost

Except of course from the perspective of financial markets QE2 has been great news. It put a quick stop to the 17 per cent stock market slump last summer and paved the way for another rally, until a little over five weeks ago when the end of QE2 began to worry investors.

Now that the political support for another bailout package has completely gone in the US, there is only QE3 that might be pulled like a rabbit from a hat to save markets from falling through the floor. How much pain can Bernanke tolerate?

He looked a bit like a man in pain himself last night. A great deal of money has been spent to engineer a recovery that is so weak that it is not delivering jobs and may be unsustainable without more money.

There are clearly limits to what US monetary policy alone can achieve as Bernanke admitted. An asset price correction looks already in progress and set to last for sometime, and then presumably Bernanke will step in to stop the very worst of a deflationary bust.

Great Depression

This student of the Great Depression knows that a deflationary bust is worse than an inflationary stagnation, and he will no doubt choose the lesser of two evils.

Inflation is a continuous rise in the mean price level. Click here to learn more. However, during the period of Great Depression, unemployment was a major concern, which led to the drop in prices and fall in demand. Prices fell also because there was no supply of money and this led the people to curb their spending out of fear.

As ArabianMoney has noted on my occasions you would then want to be invested in asset classes that would benefit from inflation like gold and particularly silver.

But everything goes down with a sinking ship, even precious metals although beware the bounce back might be very fast. That is why ‘bond king’ Bill Gross has so much cash. It is not because the US dollar has a great future. It is just that most things are priced in US dollars when they fall in value.

Will the markets now test Bernanke’s resolve with a really big sell-off? He did as good as throw down the gauntlet last night.