QE1 doesn’t seem to work, so let’s try on QE2.  And if QE2 doesn’t work, we can always trya Q3 fitting on for size.

“Monetary easing” is a much more transparent and less pompous phrase than “quantitative easing,” and affords us a much clearer idea of what’s going on when economists attempt to communicate.  Strictly speaking, either way you slice it, both phrases refer to a government monetary policy designed to increase the supply of money.  A government  in this scenario will buy government or non-government securities from the outside market. 

The easing is supposed to make financial institutions flush with fresh capital. The intention of The Fed or particular central bank that turns on the money machine, so to speak, is that markets will be quickly saturated with liquidity, and that financial institutions will facilitate increased lending.  With increased lending, the hope is that business will be stimulated to borrow, and will do more hiring.

Central banks use quantitative easing as a kind of fiscal Hail Mary pass when they’ve already lowered interest rates close to zero, and the economy failed to jump start.  To evade blame if things don’t work out, Fed economists are fond of pointing out that quantitative easing is a temporary measure to stop the bleeding, and that it is no substitute for actual enhanced productivity. 

A failed quantitative easing policy is a true setup for inflation.  One almost can feel sympathy for the economist forced to issue carefully worded announcements about what works and what doesn’t work with easing.  In an economy with dramatically increased liquidity and no increase in productivity, you have the classical inflation scenario:  too much money chasing too little goods.  Prices then rise while currency gets debased.

Another danger of quantitative easing is that it becomes a slippery slope – hence the numbers after the letters QE.  You can bet the farm if there’s a QE3, it’s because QE2 didn’t work; and if there’s a QE2 freshly injected into the economy, it’s the result of a failed QE2.  We saw this slippery slope at work in January, 2009 when The Fed purchased $500 billion in mortgage-backed bonds.  When economic conditions continued to deteriorate, the Fed initiated a second round of bond buying in the middle of March 2009.  That worked for a brief while. Then when the economy continued to deteriorate, the Fed initiated QE2 in November, 2010, and purchased $600 billion in Treasuries.

Now America sits on the precipice waiting for an announcement from The Oracle of Jackson Hole.  We can hope and pray for Q3 and twiddle our thumbs looking for the economy to jump start as a result of the stimulus.  Or, as wise and stealthy investors, we can invest in gold with confidence that inflation lies ahead, and that the prediction for gold to reach $2,000 per ounce by January 2013 makes consummate sense.  Meanwhile, gold closed today at $1,658.50 per ounce.  What do you intend to do?