The U.S. Federal Reserve Plan For QE3 – And Why It's a Done Deal

By Keith Fitz-Gerald, Chief Investment Strategist, Money Morning

When U.S. central bank policymakers conclude their two-day meeting today (Wednesday), there's really only one question investors want an answer to: What's the U.S. Federal Reserve plan for QE3?

Let me answer that for you: QE3 is a done deal - although Fed Chairman Ben Bernanke & Co. might well give it another name.

Let me explain ...

$2.3 Trillion ... And Counting

Since December 2008, when a worldwide credit crisis threatened to take down the global financial system, the U.S. Federal Reserve has had a starring role. It has held the benchmark Federal Funds rate at historic lows between zero and 0.25% to keep the U.S. economy from stalling. And it's pumped more than $2.3 trillion into the American financial system, mostly by purchasing securities on the open market.

The key to these asset purchases has been two "quantitative easing" plans. The second of the two, known as "QE2," was a $600 billion initiative that was rolled out in November. It's supposed to wind down when the second quarter ends next week - which is what the Fed promised at the end of its last FOMC meeting in late April.

When the Fed's policymaking Federal Open Market Committee (FOMC) meeting breaks up at around noon today, pundits are expecting Team Bernanke to announce that it's holding rates steady, and is winding down QE2 as promised.

But I'm just not buying this.

You see, there's a reason there's so much interest in the Federal Reserve plan for QE2 - and for its plan for the much-talked-about QE3: At some point, the Bernanke-led Fed will be forced to halt this epic stimulus initiative. And that could ignite an inflationary firestorm not seen in this country in decades - if ever. That will turn the Fed's mandate of maintaining "price stability" into a bad joke.

But, even worse, it could tip the U.S. economy into a double-dip recession, ignite widespread layoffs and drive unemployment skyward, and hammer this country's standard of living - especially in households that didn't prepare for this eventuality.

So when Bernanke takes the podium for his press conference this afternoon (his second so far this year - the only two, in fact, ever held by a sitting Fed chairman), this one question is likely to be the first one that gets asked: "Mr. Bernanke, will you, or won't you, bring on QE3?

After all, the stimulus propped up the global financial markets once before, so why won't it work again ... or so goes the reasoning.

You can certainly understand the intense interest in this element of the current Federal Reserve plan for the American economy.

Here at home, U.S. stocks just concluded a six-week losing streak, and now face the so-called "summer doldrums." The American housing market seems to be getting worse. And inflationary pressures are building even as the U.S. economy appears to be slowing down - forcing investors to face the possibility that we'll see a double-dip recession that's infected with a virulent case of stagflation.

The overseas outlook isn't that much better. In the near term, the potential for a Greek debt default seems to soar one day and plummet the next and there seems to be a general belief that it's going to happen - the only question being when. And there are long-term issues, too, including the so-called "death" of nuclear power, which promises to cause energy prices to spike in the years to come.

So what about QE3?

Given this complicated backdrop, I think it's already baked in. The Fed just won't call it that. And I think they'll play a bit with the timing.

The Federal Reserve Plan for QE3

Here's what I see: Instead of printing more money, the Fed is likely to start reinvesting the proceeds of maturing debt. Ultimately, that won't reduce our government's bloated, toxic balance sheet. But it will change the makeup of that balance sheet - and not for the better.

I believe the Fed will also attempt a freeze of some sorts that effectively removes pressure from the U.S. Treasury markets that would otherwise crater it.

At the same time, I can easily envision continued demand for U.S. Treasuries from abroad that will confound such well-known Treasury bears as Pacific Investment Management Co. LLC (PIMCO) star Bill Gross, who has been wrong on Treasuries before.

The European euro is in real trouble - and so are the institutional investors who have parked their money there. This, in turn, means that the so-called "PIIGS" of Portugal, Italy, Ireland, Greece and Spain truly do run the barnyard - a fact that will help sustain U.S. Treasuries, as well.

As for the so-called "nuclear option" that is so popular on the late-night chat boards sponsored by card-carrying members of the tin foil hat club ... don't waste your time worrying about it. China can't dump U.S. dollars, and neither can Japan. Nor can either country dump U.S. Treasuries en masse. The reality is that there is simply not another alternative on the planet capable of absorbing the proceeds if they did so. So both nations are effectively stuck.

The final reason that I'm sure that QE3 is a done deal is, ironically, a political one. Despite the fact that so much is wrong with this country on so many levels, the fact is that we're heading into an election year and that means the status quo is likely to remain in place until the new guy reaches the White House. And the status quo speaks to the inevitable Federal Reserve Plan for QE3 - even though it's in the "stealth mode" that I'm predicting.

[Editor's Note: For a related story that details how the U.S. Federal Reserve's actions will further stoke U.S. inflation that appears elsewhere in Money Morning, please click here.]