JPMorgan: QE Might Have Devastating Consequences After All

Approximately 9 years after various "tin-foil" wearing blogs first warned that the long-run negative consequences of QE will drown out and vastly outnumber any positive ones (which have mostly been confined to make the rich richer and create the illusion of economic stability built on the cracking foundations of trillions in newly created dollars), none other than JPMorgan today admits that QE may, indeed, have some devastating financial, economic and political consequences. And by some, we mean a lot.

What prompted this exciting moment of monetary introspection?

According to JPM's Nick Panigirtzoglou, it was last week's report that the BoJ has expressed concerns over negative side effects of its QE current policies (especially keeping the 10Y yield fixed around 0%), and which resulted in a sharp, if brief, global bond steepening which demonstrated once  again just how dominant central bank monetization policies are in determining the long-end of the curve.

And, as the market demonstrated, a hawkish policy shift and a subsequent reduction in duration absorption by the BoJ would intensify the quantitative tightening already in place by the Fed and the ECB, and according to JPM represents "a significant tail risk that has generated intense debate among our clients."

So what are these possible 'devastating' side-side effects from unorthodox BoJ - and other central bank - policies?

Here is a list of the key negative consequences arising from QE, from JPMorgan:

1. Results in Asset Bubbles and a Collapse in CapEx: Even as QE has likely exerted downward pressure on bond yields, the significant increase in central banks’ balance sheets makes an exit potentially more difficult, and raises the risk of a policy error or of an increase in perceptions about debt monetization. It potentially creates asset bubbles by lowering asset yields relative to historical norms, that an eventual return to normality could be accompanied by sharp price declines. Perceptions about asset bubbles can thus also increase long term uncertainty. In turn higher uncertainty might prevent economic agents such as businesses from spending, i.e. the collapse in CapEx observed over the past decade as company used cheap debt to purchase their own, making management teams richer.

2. Creates Zombie Companies and Crushes Productivity. Low credit spreads and corporate bond yields are an intended consequence of QE but not without distortions. By allowing unproductive and inefficient companies to survive, helped by low debt servicing costs, QE could potentially hinder the creative destruction taking place during a normal economic cycle. In principle, QE could thus make economies less efficient or productive over time. Which should answer the long-running debate over the chronic lack of economic productivity in the new normal. The debate about so called "zombie" companies has been particularly intense in Japan given the low business turnover rate. According to OECD, Japan's business startup and closure rate is about 5%, roughly a third of that in other advanced economies with several commentators blaming the BoJ's ultra-accommodative policies for this problem.

3. Low Rates crush savers, make the rich richer. One of the most visible impacts of QE has been the decline in discount rates, which in turn has created wealth effects via supporting asset prices. However, an argument could be made that these wealth effects are not evenly distributed, and that low discount rates mean savers suffer from an erosion of income.

4. Exacerbates currency wars. QE could exacerbate so called “currency wars”. The value of the Japanese yen collapsed after Abenomics started in November 2012 and has stayed at historical lows since then helped by BoJ's ultra accommodative monetary policy. This is shown in Figure 5 by the real trade weighted index of the Japanese yen. Japan's main competitors across EM and DM have been feeling the pressure from this depreciation, though it is not clear that the depreciation necessarily means the yen is undervalued.

5. NIRP hurts the economy, and chokes off credit supply. Beyond a certain threshold, negative interest rates can have unintended consequences such as lower bank profitability, higher bank lending rates, reduced credit creation to the real economy, impaired functioning of money markets and reduced liquidity in bond markets. And there is a good reason to believe that the threshold below which negative rates start having unintended consequences is higher in Japan than in Europe, not least because of the lower interest margins Japanese banks operate with... Deeply negative policy rates had taken their toll on Danish and Swiss banks’ net interest income (Figure 6). Net interest income as % of assets declined in 2015 for both Danish and Swiss banks following the introduction of very negative policy rates in these countries in January 2015.

6. Chokes Repo markets due to collateral shortages. It is not only commercial banks that are hurt as a result of QE. Reduced liquidity in money and repo markets is another side effect. UST collateral shortages have hampered US repo markets. The BoJ and the ECB inflicted similar damage to European and Japanese repo markets as government collateral was withdrawn at an even stronger pace. An argument could be made that the damage to trading turnover and liquidity is likely to have been even bigger with the BoJ’s and ECB’s QE relative to the Fed’s QE, because the BoJ and the ECB went even further than the Fed by lowering its policy rate to negative territory. Negative yields can hamper trading volumes and liquidity as money market participants are less willing to trade at negative yields.

7. Cripples pension funds by increasing funding deficits. Lower bond yields increase pension fund and insurance company deficits putting pressure on pension funds to match assets and liabilities. This pressure to move further away from equities and other high risk assets into fixed income is even stronger in countries like Japan where demographic pressures are more intense. For example, old age dependency ratios, i.e. the proportion of the population aged 65 years and over as a percentage of the population aged 15-64 years, have been rising steadily, with Japan aging more rapidly than the US or Europe (Figure 1). Generally, an aging population means that allocations are likely to shift towards relatively safer instruments as the ability to withstand larger drawdowns on capital diminishes as individuals age.

What is striking in Japan is that in contrast to GPIF, which shifted towards equities post Abenomics most likely under political pressure, private Japanese pension funds did the opposite shifting even more towards bonds (Figure 3).

8. QE Forces consumers to save even more. The yield-to-worst on the Bloomberg Global Agg Yen denominated bond index currently stands at close to 0.15%, around one-sixth of its average in the expansion preceding the financial crisis. In addition to the effect of deleveraging after the financial crisis and the Euro area sovereign crisis, QE has played a role in pushing down on long-term yields. Particularly the QE programs of the BoJ and ECB which have seen net issuance of government bonds outside of the public sector balance sheet turn negative, not just in their domestic economies but for the G4 on aggregate (Figure 4).

These low yields in turn depress the income that investors receive from bonds, inducing them to save even more, in the process making a mockery of the key "widely accepted" economist axiom behind QE.

9. The rise of populism and extreme political frictions. A longer-term tail risk created by QE is the potential for political frictions, which could escalate in the future especially once QE becomes a negative carry trade for
central banks, i.e. when the interest on excess reserves starts rising above the yield they receive on their bond

JPMorgan's punchline:

These political issues could become a big problem in Japan if in the future Abenomics, including BoJ's ultra-accommodative policies, are perceived as a failed experiment that brought limited benefits to the Japanese economy and society.

Now if readers expand what JPM said about the failure of QE in Japan, they may be reminded of the piece "An Orgy of Blood" by the UK's Clarmond Wealth, whose conclusion we repost below because with every passing day, the world it previews gets closer:

When historians look back and see the cavalier balance sheets of the central banks they would rightly assume there was a world war going on as every central bank balance sheet is now approaching or exceeding levels not seen since 1945. However, the worrying truth is that there are no external enemies to overcome; the central bankers are only maintaining the growth trajectory that we demand.   

The age of sloganeers

The current social contract is mired in the quicksand of global finance. It is being kept alive by the corpulent balance sheets of central banks, who do their government’s bidding so that the politicians do not have to put unpleasant choices in front of their electorates. This cowardly behaviour gives rise to slogans and sloganeers, who provide familiar but false checklists of remedies. “Take bank control”…”America First”…”One Belt, One Road”…”Ein Volk, ein Reich, ein Fuhrer”…”One Man - One Kill”. Central banks are currently furnishing the excess credit that, in the past, has been followed by an orgy of blood.


natxlaw Sat, 07/28/2018 - 14:31 Permalink

Ya think? Printing money and bailing out the folks who caused the problems? You didn’t think they’d do it again, and expect another? Fool me once.

Last of the Mi… BennyBoy Sun, 07/29/2018 - 08:46 Permalink

JP Morgan says this? That's rich. How in the hell can QE crush productivity when it is in and of itself the prime driver of the PC/SJW policy of unlimited immigration? This drives down wages and it will take decades for them to recover. Remember that middle class thingy we used to have? Have you noticed that it's umm, like . . . missing. 

The rationales some of these bankers use defies common sense.

QE kills innovation through corporate welfare, no doubt, but damn sell the nonsense elsewhere.

In reply to by BennyBoy

rbg81 Free This Sun, 07/29/2018 - 06:55 Permalink

My first reaction to reading this:   No shit Sherlock!  Many of us have been saying this since 2008.

My second reaction is:  How can a top investment bank, which supposedly employs many highly intelligent people, only NOW start coming to these conclusions after all this time?  Of course, they knew all of this from the git-go.  So why fess up now?  Something very ominious must be afoot.

In reply to by Free This

shortonoil Free This Sun, 07/29/2018 - 10:05 Permalink

The world's peripheral economies are collapsing every where, and these highly trained specialists are just beginning to notice that maybe something is wrong? That must be how they got to be bankers: they catch on real fast! When they start admitting that the perpetual growth meme is maybe a little incomplete we will know that they again have at least two neurons firing. This is like watching paint dry on the inside of an oil tank!

In reply to by Free This

navy62802 natxlaw Sun, 07/29/2018 - 00:01 Permalink

The 10-pound egg-heads only accomplished one significant thing with ZIRP/NIRP ... they delayed accountability and consequences of the 07/08 crisis. And now those consequences have grown significantly in magnitude while the Fed has expended most of its capability to mitigate the impact. When this all finally crumbles into dust, I think it will be the most significant financial crisis the world has ever seen.

In reply to by natxlaw

GooseShtepping Moron Sat, 07/28/2018 - 22:44 Permalink

Debt jubilees are absolutely pointless and ridiculous. There is no conceptual difference between a jubilee and QE. A debt jubilee would just monetize all outstanding debt in one brilliant moment rather the slow drip of money printing by the central banks. It's unbelievable to me that there are people here who despise the one while praising the other to the hilts when they are essentially the same thing.

The problem with the debt is NOT the nominal number of trillions outstanding. That is confusing the debt print with the debt itself. The problem with the debt is the fact that it represents consumption already pulled forward, resources already used, wealth already dissipated. Writing down the debt print, which is essentially all a jubilee is, does nothing to replace that lost wealth. Neither does QE or any other accounting gimmick.

The only thing that can actually liquidate the debt is a whole bunch of hard work and savings. No matter what else happens, Say's Law remains in effect. You cannot get something for nothing and you cannot consume what hasn't been produced.

Yen Cross Sat, 07/28/2018 - 22:45 Permalink

  Banksters in full reversal--- har har.

   I meant to say this, when I was ass raping your families wealth.

   Run for the hills banksters~ We're coming for you, after the Libtards are thinned out.

  Tyler, you need to show that swirl-O-gram pertaining to "you are here"?

  The derps are at the desperation stage. 😘

rockstone Sat, 07/28/2018 - 22:48 Permalink

“ so we were wrong for 10 years but we’ve got it right now! So.....ummmmm....don’t hang us by piano wire because we got this. We’re with you!!”

Ghost who Walks Sat, 07/28/2018 - 23:48 Permalink

"3. Low Rates crush savers, make the rich richer. One of the most visible impacts of QE has been the decline in discount rates, which in turn has created wealth effects via supporting asset prices. However, an argument could be made that these wealth effects are not evenly distributed, and that low discount rates mean savers suffer from an erosion of income."

This is an over-simplification of the problem that confronts modern civilizations. Apart from the lower rates for savers, the beneficial ownership of key assets is also a big problem.

I keep hearing about the GINI ratio or index indicating disparities in wealth within individual countries.

This disparity in wealth can accelerate once the elites of a country get their hands on political as well as economic power. I saw this in action in Burma. Looking at this map, it can be inferred that as a society has a greater disparity of wealth it becomes less secure. Just look at Mexico and Canada versus the US. Anyone want to shift to South Africa?,_income_inequality_distribution_by_country_per_World_Bank.svg

In a Zero-sum game the only way the rich can get richer is to shift wealth from the majority. In Myanmar where there are people in poverty and just subsisting, a disparity in wealth can be a cause for armed conflict.

If the game is not zero-sum, and wealth is expanding and the bulk of the population are seeing their lives improve, then there is social stability. China and Thailand are examples of expanding economies and stable societies.

A lot of economic theory on wealth creation varies from the application of those theories with regards to ownership of income producing assets. Too often on Zero-Hedge this is attributed to a Jewish Conspiracy. The equivalent problem in South-East Asia is Chinese-ownership of assets. While the Jews and Chinese can see the economic benefits of ownership of income producing assets, many Economists and Bankers seem blind to this, with regards to the effect of concentration of ownership on social stability. Apart from Anti-trust laws in America, and the various Foreign ownership laws around the world that limit % ownership in local enterprises, there isn't much being done to protect the public or encourage wider ownership of income producing assets. To borrow a phrase that is becoming popular "Where we go one, we go all".