What QE2 Has Done For You (So Far)

Whether it works or not in the long run, the Fed’s easing program has helped millions of investors.

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If you've got an investment portfolio, you might want to send Ben Bernanke a thank-you note.

The Federal Reserve Chairman has been battered over his aggressive and unorthodox efforts to juice the economy, with criticism mounting every time he pulls another lever. The Fed's second quantitative easing program, which started in November, has particularly animated critics who fear it will unleash runaway inflation down the road, without a decisive impact on the economy that might justify such a risky move. By buying $600 billion of Treasury securities through mid-2011, the Fed is effectively printing money while encouraging investors to buy stocks, commodities, and other assets as they sell low-risk Treasuries to the Fed. Bernanke says the Fed can rein in its program if inflation becomes a problem, but critics from left, right, and center aren't so sure.

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At the moment, however, the Fed can at least claim some credit for helping repair household finances for millions of Americans. The Fed's latest "flow of funds" report shows that U.S. households added $1.2 trillion to their combined net worth in the third quarter of 2010, an important step toward rebuilding wealth that evaporated during the recession. Household net worth is mostly made up of home equity and financial investments, and steep declines in both since 2007 have been one of the primary causes of depressed consumer spending and moribund confidence levels. Americans feel worse off because they are, in fact, worse off. The overall economy could suffer for years as a result.

The Fed's official mandate is to keep inflation in check and unemployment low. But there are a variety of ways to do that, and the Fed has clearly settled on a strategy of boosting stocks, with the hope that improved household finances will lead consumers to spend more. That would increase demand for goods and services, which sooner or later would force companies to start hiring in order to ramp up production and meet the higher demand. In theory, at least.

A lot of things have to fall into place for this "wealth effect" to have the desired result, but so far, the Fed is getting what it wanted. QE2, as the latest easing plan is known, didn't begin until November, and the flow-of-funds report only shows net-worth data through the end of September. So the program wasn't even in effect during the period when wealth went up by $1.2 trillion. But Bernanke announced his plan for a second round of easing at the end of August, and the Fed then let the markets digest the news for a couple of months before actually putting it in place.

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The plan went according to script. Stocks were essentially flat all summer, as the markets absorbed worrisome news about the debt crisis in Europe, a slowing U.S. economy, and other disquieting trends. But after Bernanke's QE2 announcement, stocks surged. From late August through the end of September, the S&P 500 rose by nearly 10 percent, as investors anticipating the Fed's move prepared for a stock market rally. Since home values continued to decline in the third quarter, that $1.2 trillion gain in net worth came almost entirely from stocks—and virtually all of it came after Bernanke announced QE2.

Although the data's not in yet, household net worth has continued to increase. Since the end of September, stocks have risen another 8 percent or so, and not because of a rosy economy. Most economists actually expect growth in the global economy to slow in 2011, as fiscal stimulus in the United States and many other countries—which helped goose growth in 2010—fades. Europe may even endure another recession in 2011, thanks to steep cutbacks in government spending and a debt crisis that has so far brought down Greece and Ireland and could spread further. And corporate profits, which hit record levels in 2010, are almost certain to fall in 2011. Under normal circumstances, those trends could easily induce a pullback in stocks. Yet the markets have withstood those worries and soldiered on.

Many families remain in a deep hole, with household net worth still down about 14 percent, or $9 trillion, from the peak of $64.2 trillion in 2007. Home values have been falling since then, and probably still have a way to go before bottoming out, perhaps in mid or late 2011. But the value of Americans' financial assets bottomed out in the first quarter of 2009, as the Fed introduced its first round of quantitative easing. Since then, Americans have regained nearly $6 trillion of lost wealth, thanks largely to the Fed's maneuvers.

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A huge unanswered question is whether those stock market gains are sustainable, or whether they're completely artificial and likely to be erased if and when the Fed unwinds its unprecedented interventions. Critics of QE2 point to another unexpected development as evidence that easing is a failure. By buying huge amounts of Treasury securities and boosting demand for them, the Fed expected that interest rates paid to investors would fall. That should have driven down interest rates on mortgages and other types of long-term debt as well, lowering borrowing costs for home buyers and companies taking out loans to finance investments. But long-term rates have actually ticked upward since QE2 began, a sign that the Fed isn't as powerful as it might wish it was.

Another unexpected factor is the tax deal negotiated recently by President Obama and Congressional Republicans. That deal includes deeper tax cuts and more spending than most analysts expected, and amounts to the kind of fiscal stimulus that Bernanke has practically been begging for. The Fed kicked off QE2 in November—despite the reservations of some of its own policymakers—largely because nobody else in Washington was doing anything to boost the economy. But if the tax deal gets passed and goes into effect, the case for the Fed's easing would get weaker.

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Bernanke has promised that the Fed will remain flexible, which means it could implement QE3 in 2011 if the economy remains weak—or end QE2 prematurely, if it suddenly seems like the economy doesn't need it. Once easing is over, we'll have a much better idea of whether it helped or didn't. But for now, Bernanke may be one of the best friends investors have.

Twitter: @rickjnewman