In the end, the Fed didn’t really have a choice.
Given that markets had already priced in quantative easing part 2 (QE2), they had to deliver. Failure to do so would have meant the kind of falls in asset prices they are devoted to avoiding. Hence the gung ho announcement that the Fed will chuck out an extra $600bn of cash by the end of June 2011.
The idea behind the whole thing is simple enough: the Fed can’t cut interest rates any further via traditional routes, so instead it buys government bonds, pushing their prices up and their yields down. Any debt priced off those yields then gets cheaper. It all, or so the theory goes, kicks up asset prices and makes everyone happier to borrow, spend and hire rather than squirrel and save. But, simple as it sounds, creating money in this kind of volume is extreme stuff.
The first round of QE made sense, given the post-Lehman crisis; but we aren’t in that kind of crisis any more. To CLSA’s Chris Wood this makes QE2 a “mad experiment”, one which will eventually lead to the collapse of the US dollar and one in which “the Billy boy-led Fed has crossed its Rubicon by presenting QE as part of the routine of monetary policy” rather than what it is – something deeply unorthodox.
He is right. But, however nuts it might seem, the real question is: will it work? The consensus appears to be no. As Bill Bonner likes to point out, if printing money somehow created wealth, we’d all be applying for work visas to Zimbabwe.
It is also worth remembering that QE1 didn’t exactly kick off a massive releveraging of the US economy. Instead, savings rates have risen over the period of the crisis and companies have concentrated on paying down debt, not taking out more.
QE in itself doesn’t change the fundamentals of a rubbish economy. However, that doesn’t mean that extreme monetary policy isn’t of interest to investors. Far from it.
A note from Fidelity points out that QE2 involves buying government bonds, not stocks, and goes on to say that “any positive impact on stocks will come via a recovery in the economy”.
That’s not what happened last time. There was no recovery, but there was a huge rise in the stock market. That’s already happening again: the FTSE hit two-year high on Thursday. Why?
Because the fact that the QE cash is used to buy bonds is by the by when it comes to the end effect. Whatever it buys, it puts cash into the market merry-go-round. Sell a bond to the Fed and you have cash, which you can use to buy another bond, perhaps from someone who then uses the money to buy a share, perhaps from someone who buys into an Asian market from someone who then buys a gold exchange traded fund (ETF). The money becomes a hot potato leaping from asset to asset and leaving little bubble seeds behind it at each stop. The economy doesn’t have to recover for QE to hit asset prices. No, all you need for that is liquidity.
So, what do you do? You can note that, thanks to all this, new bubbles are emerging everywhere and then decide whether to jump on them. Then note that if you do, for now at least, it may not really matter what you buy. Any old Asian or resource fund or metals ETF should do it. But if you want to join the fun and not lose too much money should it go wrong, you do need to think a little about what you buy.
So, get well-priced international defensives (just get the Personal Assets Trust (LSE: PNL) as a proxy for this) and make sure you have gold as a hedge against the inflation that QE1, 2 and 3 (it’s bound to happen) will bring.
You can, says Adam Ferguson, author of When Money Dies – the Nightmare of the Weimar Hyperinflation, use QE, which really does boil down to little more than printing money, to postpone your day of reckoning in the hope that “economic recovery will come in time to prevent higher unemployment or deeper recession”. But what if it doesn’t? Hello stagflation.
Otherwise, for those that like a little excitement, there is copper. It’ll get its QE boost like everything else but it is also one of the few metals (rare earths aside) that most agree will soon see a genuine shortage of production.
Add that to the fact that both JP Morgan and iShares have announced the launch of physically-backed copper ETFs – which implies piles of copper being removed to warehouses – and you can see how the price might keep rising regardless of the low levels of consumption in the west (copper demand is related to construction) and its already high price.
Whatever you buy at the moment, do be ready to take your profits. Take QE out of the equation and it is hard to find value. And, as Mizuho’s Jonathan Allum says, all too often “today’s hot potato becomes tomorrow’s organic compost”.
• This article was first published in the Financial Times