The Diminishing Returns Of Central Planning, And Why More Printing Would Have No Impact

Now that all the rage is now just the NEW QE, but global coordinated NEW QE, it would make sense to observe the impact the last three episodes of quantitative easing, QE1, QE2 and Twist, have had on the market. And more importantly, whether such impact is rising, dropping, or staying the same. Well, as the following chart from BofA shows, we may be lucky if there is any favorable impact on risk assets following the announcement of more easing, and incidentally perhaps global easing is what is necessary (if not sufficient) now that the devaluation of the US dollar has become an exercise in futility. Because it now appears that only an absolute currency devaluation would work, not a relative one. What is another way of saying this: a global devaluation of all currencies relative to some benchmark... say gold. Most importantly, the only question now is how long before the entire "global intervention rumor" is faded, and what happens when the market realizes that suddenly, Syriza not winning the Greek elections is the downside case as it would mean no coordinated central bank intervention. Great job central planners - you have just shot yourself in the foot once again.

The full thoughts of BofA:

There are low rates, and then there are low rates


Of course, rates are already quite low. But it matters why they are low. Right now, much is due to a flight to safety; fear is not a good environment for growth or market rallies. Replacing that fear with a policy commitment to further support the recovery should be a net positive for the outlook. Indeed, this confidence channel is an important one: the Fed can put a floor under sentiment and prevent a selffulfilling negative spiral like what immediately followed the collapse of Lehman. Moreover, QE3 should price out deflation and “Japanification” fears.


One counter to these potential benefits is that low rates hurt savers. While true in isolation, the plausible alternative is not higher rates. It is an even deeper economic quagmire, even more negative sentiment, and likely similarly low rates.  No one — savers or otherwise — would benefit from that situation.


The law of diminishing returns


The other counter is that QE3 will have less benefit per dollar than earlier programs. That might well be correct — a recent San Francisco Fed study lends support to that view (Chart 7) — and Bernanke and Yellen both acknowledged that risk recently. But it is worth exploring the reasons why.


QE1 may have had a large effect because of nonlinearities that increase in size. If so, that argues for a larger QE3 program (and against a small extension of Twist). QE1 also improved market functioning during a crisis and signaled easy policy for a while. Forward guidance has since usurped the latter effect. Market functioning was much less of a problem during QE2 or Twist; if fears of European contagion lead US market liquidity to falter, however, QE3 could have larger effects.

Or, as the chart actually implies, more easing would have no impact whatsoever...