(October 26, 2011) — A research paper published earlier this month asserts that cries for a third round of quantitative easing will grow steadily louder during the rest of the year, yet are unwarranted.

“The central banks aren’t’ responding to economic forces but to the securities market,” Michael Litt, founder and chief investment officer at Arrowhawk Capital Partners, tells aiCIO and explains in his research report titled “Cold Turkey,” noting that monetary policy is thus becoming less associated with the actual economy. “In fact, the economy of the United States is doing moderately well.”

According to Litt, QE3 would be incrementally less effective in stimulating US economic activity, creating a global arbitrage where investors borrow in US dollars, sell those US dollars, and then buy bonds from other countries with higher-yield currency units. Consequently, with QE3, Litt perceives an environment where little money flows into the US economy, with the Federal Reserve’s policy supporting only certain currencies while doing nothing to stimulate growth in the US.

Proponents of QE3 say the policy would support wealth — increasing the value of assets in the US — as well as improving consumption and demand psychology, but Litt argues that the policy would accelerate hyper-growth in emerging markets and commodities. “What institutional investors may perceive as structural growth in emerging markets and commodities is in fact misperception,” Litt says. “It’s growth based on extremely high and unsustainable credit expansion in those markets.” QE3 would only fuel a dangerous addiction to ‘virtual’ accommodative monetary policies in emerging and commodity-based economies, he says.

Institutional investors, therefore, need to understand that growth in emerging markets and commodities is in part  a response to US monetary policy, Litt argues. “QE3 would lead to overvaluation in emerging markets and commodities,” he concludes, adding that if the policy is pursued, a potential rally in both sectors would be the opportunity for institutional investors to go underweight in those markets.

He writes: “Weakness in global financial markets will act as a siren song on the Fed to feed the addiction. By responding, the Fed would allow for avoidance in dealing with the root causes of low monetary velocity in the US.” The report by Litt states that QE3 would not address the underlying causes of low US monetary velocity, asserting that pleas for QE3 are emblematic of financial markets having become addicted to liquidity injections more than has the real economy. The report concludes: “The fact is that despite the significant liquidity injections from QE1 and QE2, the US Money Multiplier remains stubbornly low. The anemic money multiplier is not the result of insufficient reserves; it is primarily a problem of banks’ uncertainty with respect to their reserve requirements. Attorney Generals across the US are trying to make a name for themselves by suing the banks over their past mortgage transgressions. Further, reserve capital requirements under Basel III have yet to be determined, and the current proposals place an excessively high burden on reserves for US banks holding mortgages. Each of these is inhibiting credit creation and monetary velocity in the US.”

The negative predictions by Litt on a possible QE3 by the Fed follow similarly negative statements made by Pacific Investment Management Co.’s Mohamed El-Erian, Bill Gross, and Berkshire Hathaway’s Warren Buffett — who all said the US does not currently need an economic stimulus.

El-Erian has said that the cost of the Federal Reserve’s actions with its quantitative easing program is starting to outweigh the benefits. In an interview earlier this year with CNBC, El-Erian said the central bank should calculate how it can exit from its multi-trillion dollar quantitative easing program. Federal Reserve Bank of St. Louis President James Bullard has said the central bank is “determined” to get monetary policy back to normal, confirming that policymakers could subtly adjust its plan by backing off early from QE2, the Wall Street Journal reported.

Meanwhile, Gross wrote: “Bond yields and stock prices are resting on an artificial foundation of QE2 credit that may or may not lead to a successful private market handoff and stability in currency and financial markets.”