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Big-name investors pull no punches on QE2

Fed Chairman Ben Bernanke


If the U.S. Federal Reserve is still mulling the pros and cons of introducing another round of stimulus to revive the sluggish economy, two investing heavyweights have some advice for the central bank: Be very careful.

Jeremy Grantham, chairman of global investment management firm GMO LLC, and Bill Gross, managing director of Pacific Investment Management Co., attacked the Fed through their respective letters to investors, using language normally reserved for the incompetent and devious.

Mr. Gross likened the Fed's policy to a "Ponzi scheme," while Mr. Grantham called it "dangerous" and "desperate." Together, these two investors oversee assets valued at nearly $1.4-trillion (U.S.), suggesting that Fed chairman Ben Bernanke might be reading along.

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But why are they so critical? Investors have cheered ever since the possibility of another stimulus effort - known as quantitative easing - was first floated in late August, sending the S&P 500 up as much as 13 per cent over the next eight weeks.

The first round of quantitative easing - essentially printing money to buy government bonds - was introduced during the worst days of the financial crisis, and largely credited with rescuing the global economy from the abyss. Investors see a second round, cutely known as QE2, as a cure-all for high unemployment, a depressed housing market and a U.S. stock market that is still well off its 2007 highs.

Mr. Grantham sees it another way. He says the Fed is manipulating stock prices higher, inflating a bubble that will ultimately burst.

"It is probably the most dangerous thing to inflict on a peacetime economy with two possible exceptions - runaway inflation and a housing bubble," he said in his note. "So, not only have these two Fed bosses [Mr. Bernanke and his predecessor, Alan Greenspan]been almost criminally inept in ignoring stock bubbles, they have also deliberately instigated them as a policy tool!"

That said, he believes that a speculative rally could take the S&P 500 as high as 1,400 or 1,500 within a year, if there is no double-dip recession. But such a run would leave stock prices "badly overpriced."

Mr. Gross is less scathing about the Fed because he spreads the blame for the current financial mess to include politicians and even regular consumers. Even so, quantitative easing looks to him like a Ponzi scheme, with a twist.

"There is no need - as with Charles Ponzi - to find an increasing amount of future gullibles, they will just write the cheque themselves," he said in his note. "I ask you: Has there ever been a Ponzi scheme so brazen? There has not."

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Even so, he is also doubtful that another round of quantitative easing will work because monetary policy is now in a liquidity trap, where low interest rates and asset purchases will not stimulate borrowing or lending.

The stakes are high. "If QE2 cannot reflate capital markets, if it can't produce 2-per-cent inflation and an assumed reduction of unemployment rates back towards historical levels," Mr. Gross said, "then it will be a long, painful slog back to prosperity."

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