What QE3 Means for Markets and the U.S. Economy

We finally know that a third round of quantitative easing, or QE3, is here, but it has left investors asking what it means long-term for the markets and the economy.

First, let's look at what QE3 is meant to do.

QE3 is meant to encourage economic growth and improve the U.S. employment picture.

On Sept. 7, the Department of Labor reported that only 96,000 jobs were created in August. Not only was that far below expectations, it was well under the 141,000 increase from July.

In addition, the underlying foundation is even weaker as income is down and more Americans are leaving the labor force. Of the jobs that are being created, most are poorly paying ones in the service sector.

From that, economic growth for the United States slowed to 1.7% in the second quarter, down from 4.1% in the final three months of last year.

This new QE3 - or QE Forever, since it has no expiration date - is the most intense program initiated by the Fed to goose the economy since the crisis.

Noted Julia Coronado, the head economist for North America at BNP Paribas and former Fed economist, "This is definitely a significant shift in FOMC policy. This is a very aggressive commitment to success on its mandates."

Here's what QE3 means for the markets and the U.S. economy.

QE3: Bullish for Markets

QE3 will consist of the Federal Reserve inflating its balance sheet to buy $40 billion of mortgage debt a month.

This is needed as, according to Fed Chairman Ben Bernanke, "We're looking for ongoing, sustained improvement in the labor market."

Indeed, Bernanke has high hopes for QE3.

He stated that, "By assuring the public that we will be prepared to take action if the economy falters, we're hopeful that that will increase confidence, make people more willing to invest, hire, and spend...Our mortgage-backed securities purchases ought to drive down mortgage rates and put downward pressure on mortgage rates and create more demand for homes and more refinancing."

The Dow Jones Industrial Average rose Thursday after the U.S. Federal Reserve announced QE3, even though QE3 in itself is a very significant statement that the economic woes of the United States remain prevalent.

While QE3 will weaken the U.S. dollar, it has lit a fire under gold, silver, and stocks.

Just look at the accompanying chart. The U.S. dollar (NYSE: UUP) has plummeted in recent trading action. Over the same period, gold has soared (NYSE: GLD).

That transpired from traders reacting to very poor economic reports for the United States. As a result of the lingering weakness in the American economy, the market anticipated that the Fed would pull the trigger on QE3.

As the chart also shows, the worse the news about the U.S. economy, the better the Standard & Poor's Index has performed, surging right along with the price of gold.

But with QE3 weakening the U.S. dollar, investors shouldn't lose sight of the big picture. While Bernanke is optimistic about what QE3 will accomplish, what QE1 and QE2 have achieved has been precious little at a cost of trillions in obligations for the U.S. government.

As legendary investor Jim Rogers once stated, "A weak currency is a sign of a weak economy which is a sign of a weak government."

QE3: Bearish for U.S. Economy

With the fiscal cliff fast approaching in January 2013, which could send the U.S. economy into recession from its $530 billion in tax increases and spending cuts, QE3 presents additional burdens on the U.S. government, which means burdens for the U.S. economy, and the U.S. taxpayer.

What should concern every American is that no other investors, either foreign or domestic, want to buy the assets that the Federal Reserve has acquired over The Great Recession.

In mid-2007, the balance sheet of the Federal Reserve had about $700 billion in assets. As a result of QE1 and QE2, that figure has soared to about $3 trillion in assets.

It is important to remember that these trillions in assets bought by the Federal Reserve, and thus the American taxpayer, are securities that no one else wanted at such low interest rates. If there had been other buyers, there would have been no need for QE1, 2 or 3. The Federal Reserve, and thus the U.S. taxpayer, has become the buyer of last resort for unwanted securities.

This weakness in the U.S. economy now has the Federal Reserve sailing deeper into uncharted waters as it doubles down with QE3.

QE3 will increase by hundreds of billions the potential obligations of the U.S. taxpayer. If economic conditions improve, then the trillions in assets on the Federal Reserve balance sheet acquired during QE1, 2 and 3 will be sold without a problem, potentially even at a profit.

But that has not happened on any notable scale as the balance sheet of the Federal Reserve as increased through the purchases of trillions in securities no other investors wanted.

That's why the long-term broad economic implications of QE3 are very bearish, no matter how bullish the stock market is in the near term.

Republic presidential candidate Mitt Romney wasted no time to point out how QE3 reveals the overall weakness in the U.S. economy.

"The president's saying the economy's making progress, coming back," said Romney. "Bernanke's saying, "No, it's not. I've got to print more money...I think printing more money, at this point, comes at a higher cost than the benefit it's going to create."

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