QE2 has, in practice, been an “Alice in Wonderland” policy. This disorients the markets to the point that a declared “buyer at any price” (the Fed) is able to buy more cheaply because of fears that the buyer’s debt monetization policy will result in global inflation.
In the commodities and energy complexes and other liquid markets (stocks) that are “always and forever” momentum-driven by excesses in monetary policy; the Mad Hatter Bernanke’s actions are translated into actual – and exportable – speculative behaviour, which has the self-fulfilling effect of generating short-term headline inflation.
But the Mad Hatter at the FOMC tea party knows full well that he is merely, and temporarily, holding back enormous deflationary pressures (the wage rate imbalances that have driven global macroeconomics for a decade – the impact of which was obscured for a long while by the massive debt bubble) from bearing down on the developed world.
He isn’t mad at all, he understands that if he can use inflation expectations to (continuing the Alice metaphor) freeze the hands of time so that a recovery might ensue before deflation crushes wages, prices, and real asset values in the U.S. (and it is still wreaking wages on a real basis despite QE2); he may be able to avoid seeing the debt overhang in global imbalances resolve themselves in less attractive ways, from the point of view of the chief regulator of the banking system .
In Alice in Wonderland, the Mad Hatter asks a riddle: “Why is a raven like a writing desk?” When Alice gives up, the Hatter confesses that he hasn’t the answer himself. When QE2 ends (unless it is continued – and I wouldn’t exclude the “Japanese-style” deflation-fighting posture as a possibility), the markets will normalize and clarify that it wasn’t the answer either.
Bill Gross, Warren Buffett, and others, have recently misread the tea leaves at this tea party.