There's probably no better person to assess the state of this economy than Richard Koo, the Nomura economist whose book The Holy Grail Of Macroeconomics is all about the unique nature of a post-crisis, deleveraging, balance sheet recession.

So when he speaks out on QE2, it's a must read.

The first key points from his new report are encapsulated in this chart, which confirms that QE2 has had no positive impact on the money supply. There's simply no connection. The world is NOT awash in cash.

So in light of that, what has QE2 done?

When the Fed buys a specific asset (in this case, longer-term Treasury securities), the price of that asset rises. That prompts private investors to re-direct their funds to other assets, which leads to a corresponding increase in the price of those assets.

And thus the impact on other markets:

The only remaining destinations for these funds were equities, commodities, and real estate. Real estate had just been through a bubble and remained characterized by heavy uncertainty. In commercial real estate, for example, banks—at the request of US authorities—are engaging in a policy of “pretend and extend” and offering loans to borrowers whose debt they would never roll over under ordinary circumstances. That means that current prices do not accurately reflect true market prices. Housing prices, meanwhile, resumed falling late in 2010.



UK house prices have been falling since mid-2010, and the Halifax House Price Index dropped 1.4% in April 2011 alone (the decline was 3.7% on a y-y basis).



The only remaining options for private-sector investors have been stocks and commodities. That, in my opinion, is why both markets have surged since the announcement of QE2.

His conclusion: QE2 was a huge gamble, and the end of these bubbles could exacerbate the great recession.

Click here to see Koo's classic presentation on the balance sheet recession >