Stocks have been on the rise recently, thanks in large part to speculation that the Federal Reserve will engage in more quantitative easing to spur the economy. But fund manager John Hussman says there’s just one problem with “QE2”: It addresses issues that aren’t actually the cause of the economy’s problems.

In his latest market commentary, Hussman says further easing is presumably designed to lower long-term interest rates and drive real interest rates into negative territory, which would theoretically stimulate loan demand; and to increase the supply of reserves that banks could lend.

But Hussman says the current problem isn’t that banks lack money to lend, or that interest rates aren’t low enough to stimulate loan demand. Rates are already extremely low and banks and corporations are already awash in cash, he says. “In short, further attempts at QE are likely to have little effect in provoking increased economic activity or employment,” he says. “This is not because QE would fail to affect interest rates and reserves. Rather, this policy will be ineffective because it will relax constraints that are not binding in the first place.”

The real issue, according to Hussman, is that consumers and businesses are finding their debt levels too high in relation to prospective income and are thus deleveraging rather than taking on more debt, and that banks aren’t finding enough attractive lending opportunities to put their vast reserves to work. “The best course for the Federal Reserve is to identify specific constraints within the U.S. banking system that create barriers to sound lending, and to formulate specific policies to relieve those constraints,” Hussman says. “Throwing a trillion U.S. dollars against the wall to see what sticks is not sound monetary policy. By pursuing a policy that relaxes constraints that are not even binding, depresses the U.S. dollar, threatens to destabilize international economic activity, encourages a ‘boom-bust’ cycle, provokes commodity hoarding, and pops off the Fed’s last round of ammunition absent an immediate crisis, the Fed threatens to damage not only the U.S. economy, but its own credibility.”

Hussman’s advice for investors: “Reduce risk”. He says valuations in most risk assets are high. The Fed’s policies, he says, have pushed investors into riskier assets not because those assets are attractive, but because miniscule fixed-income yields leave them with no other options. He also says he thinks a successful new round of quantitative easing is fully priced into the market, which means anything short of success could be trouble for the market. He also offers some interesting thoughts on why the relaxing of “mark-to-market” standards has obscured what it really happening on financial firms’ balance sheets.