QE forever and ever and ever and ever............

QE forever ever and ever,ever....

 QE has potentially severe implications for inflation, but not directly from the QE itself. Instead the inflation will come as a result of a dramatically increased total money supply resulting from bank lending. QE does enable more bank lending, but the lending must take place for the total money supply to grow....which it still isnt...


It is said that if consumers know that something will cost less in the future (even if it’s just 2% less) they will defer their purchases indefinitely, perhaps waiting for the cost of their desired product or service to approach zero. They argue that this can push an economy into a deflationary spiral of falling prices and diminished demand which may be impossible to escape

But this idea ignores the time value of a product or service (people will tend to pay more for something they can enjoy sooner rather than later re;I-phones etc) and the economic law that shows how demand goes up as the price falls. But common sense has absolutely nothing to do with the current practice of economics. Instead, the argument is that inflation is needed to seed the economy with demand.

However, this argument is merely a smoke screen. The only thing that inflation can do is to help governments spend. Economies do just fine with low inflation. In fact during the late 19th century, the United States experienced sustained deflation while creating much faster economic growth than we have seen in the last few generations. As recently as during the early 1960s the U.S. experienced consistently low inflation (barely 2%) and strong economic growth based on government figures. But in their call for more inflation, modern economists tend to forget or downplay those periods. 


Stopped...for now....

The Fed has ceased its program of quantitative easing (QE) and may soon begin to raise interest rates. Japan has embarked on an even more aggressive program of QE. The European Central Bank (ECB) has just begun QE. In a related development, the Swiss National Bank (SNB) recently stopped pegging the Swiss franc to the euro. 


What does it all mean?

QE’s direct and indirect effects are complex, and the fact that various policies are at different stages of implementation doesn’t make it any easier to understand the dynamics.

In the normal functioning of a reserve banking system ,commercial banks create money when they take deposits and make loans.

Central banks limit the amount of money that commercial banks can create by managing reserve requirements. They provide liquidity to the banking system by lending directly to banks through the discount window. Central banks also influence interest rates and the pace of money creation by buying and selling securities through open market operations.

 The primary objective and typical standard of success for central banks is for stable prices....HA! Well at least thats the plan...


Quantitative Easing for dummies..which is probably all of us,including the Fed

QE is not money creation; it’s more accurately a reserve creation. A central bank buys securities and pays for them with bank reserves (liabilities of the central bank and assets of commercial banks), thereby increasing the central bank’s balance sheet and the reserves of its member banks.

 The linkage between QE and the money supply is indirect. Banks will use new reserves to create money, but only when reserves are an active constraint on lending. When banks do not wish to lend and/or borrowers do not wish to borrow, then reserves are an inactive constraint. When banks seek to increase their capital and borrowers strive to pay down their debts, QE does not increase the money supply and therefore does not cause inflation. 


Has it worked??? 

During the global financial crisis , the first round of QE was effective in averting a financial collapse. A central bank can act as lender of last resort by making loans directly to individual banks through its discount window. During 2008, however, many distressed financial institutions were not banks and so did not have access to the discount window. Through QE, the Fed and the Bank of England (BOE) provided liquidity to the financial system by buying large quantities of securities from the market rather than waiting for banks to show up at the discount window.


Beyond providing the liquidity necessary to avoid financial panics and bank runs, can QE increase economic output and employment? 

Some believe that, when an economy is operating below its potential growth rate, lowering interest rates to inflate capital asset prices indirectly stimulates the economy through a wealth effect: People who own stocks, bonds, and houses will spend more if they feel wealthier.

However in this case people are becoming ,more and more aware that by intentionally inflating capital asset prices distorts markets, creates bubbles, and leads to a probable repeat of what was seen in 2008. And with the banks unwilling to loan ,the "wealth effect" is barely being felt.


Money Printing

Money printing is different from QE. Money printing is inflationary by definition. If the central bank rapidly prints a lot more currency and immediately puts it into circulation, then more money is chasing the same amount of goods and services. 

 A central bank may monetize the national debt—and facilitate increasing the deficit—by purchasing newly issued government bonds with the proceeds transferred into the checking accounts of government agencies. This, too, amounts to printing money. In other words, QE plus substantial fiscal stimulus is money printing and may cause inflation.


What’s Happening Now?

Initially QE was not paired with fiscal stimulus. Banks chose to hold the proceeds of QE as excess reserves rather than increasing their pace of lending and thereby creating money. While QE was in progress, the Fed and the BOE were pushing on a wet noodle. 


So far then, QE is not inflationary. It may become inflationary if it achieves its intended purpose of stimulating more economic activity by fueling bank lending and money creation..


The ECB have just started their QE game. Because of the concern about already unsustainable levels of government debt, Europe appears unlikely to pair this QE with fiscal stimulus. The ECB will probably be pushing on the same wet noodle, as were the Fed and BOE. 

Japan, however, is flirting with a more aggressive form of debt monetization, combining QE with increasing fiscal deficits. The country seems close to testing what happens to a modern developed economy when it intentionally chooses money printing as its macro-economic policy….so if you want to know what we may have to look forward to,it’s the land of the Rising Sun that will probably give us the best clues,which means that there could very well be years more of the same old.... 


Even the mainstream media is waking up to the problems created by central bank manipulation

It is expected for a return to "happy days" that annual growth of about 2.5% is required,however since the peak in 2007 we have a compounded growth rate of just 1%!!!!

It would be nice if market participants could actually agree on what all these years of bond buying has done for the economy. But they can’t. So it’s not surprise that why no one can agree on what the end of QE will actually mean for the markets or the economy.

Take, for instance, the difference between the Federal Reserve’s own predictions for inflation and the future path of interest rates and what the bond markets think will happen. 

The main goal seems to have been the hope that an expensive stock market will give people the confidence to spend. Fed officials would probably argue that higher asset prices are merely a second-order effect of their policy and that Zero rate policy was implemented  in an effort to get businesses to invest. But either way, the policy requires growth in demand to organically materialize within the economy so that there are people and firms willing to invest at these new low interest rates.

And it’s this last part that really hasn’t come to fruition. Job gains continue to accelerate, but wage growth is flat.

Economic growth in 2015 has been lackluster at best,with  YOY GDP forecasts from Goldmans, Barclays, Nomura and JP Morgan between 2% to 2.2%.. this is  still far below what you would normally see in a recovery.


We seem more and more reliant on the US to support global growth,but with so many other issues to look forward to this month (NFP,OPEC meeting,currency wars,Bond market stability,Grexit & Chinese stock market volatility) ,by the end of it we may have a better idea if the US will raise rates this year or if we will be on hold for ever and ever and ever and ever.......



In regards to more detailed options and futures advice ,please contact Darren Krett through www.maunaki.com or dkrett@maunaki.com