Western financial markets are “fixated” by the prospect of another dose of printed money in the US, says Liam Halligan in The Sunday Telegraph. Last week the Fed signalled that it would launch another round of quantitative easing (QE) if the economy deteriorates. The electronically created money is used to buy long-term bonds – in the first round of QE these included Treasuries, corporate debt and mortgage-backed securities – in the hope that this will cause long-term rates to fall and banks to lend, thus stimulating growth.
Will it work?
So would it work? It seems unlikely, says David Rosenberg of Gluskin Sheff. The first round didn’t. If it had, the Fed would hardly be contemplating another round after cutting its growth forecast twice in the last three months. Capital Economics points out that, by the end of the first QE programme, Treasury yields were around the same as when it started; a broad measure of the money supply, M3, was lower once QE1 ended.
QE1 was “lost in transmission”, as Lex puts it in the FT. The basic problem is not that the price of credit is too high but that there is scant demand for it. Consumers, who comprise 70% of the economy, are busy working off their huge debt loads. It appears they’ll be “stuck in the mire for years to come”. Their debts are still 120% of disposable income. That’s down from a peak of over 130%, but a far cry from the more sustainable sub-100% level that would pave the way for them to become “an engine of growth again”, says Capital Economics.
And given the low demand for debt now that the bubble has burst, banks – buffeted by existing major losses and the prospect of more write-downs, including those from a probable further down-leg in the housing market – are using money to bolster their reserves rather than lend. The trillion-plus dollars that banks received via the Fed buying mortgage assets certainly didn’t go into lending, says John Mauldin on Investorsinsight.com. So “what is to make us think” that another dose of QE “will make them feel like they have too much money in their vaults”?
With the usual transmission mechanism between the Fed and the economy damaged, more QE is unlikely to help. According to Morgan Stanley, former Fed governor Larry Meyer has put together an estimate of the impact of another $2 trillion of asset purchases. He reckons it would lower bond yields by 0.5%, and improve GDP growth by 0.3% in 2011 and 0.4% in 2012. But Meyer says these are high-end estimates. “Not much bang for the buck”, says Mauldin.
Pushing on a string
If another dose of QE is tried and doesn’t work, it will be clear that the Fed is “pushing on a string”, and fears of Japanese-style deflation will grow. “History is repeating itself,” says Buttonwood in The Economist. Core inflation in the US is under 1%. Two years after the Fed slashed rates to zero, ten-year bond yields are around the same level as Japanese yields two years after Japan’s short-term rates slid to 0.5%. “The more the outlook turns Japanese, the harder it will be for equity markets.”
There’s also the danger that all this printed money will cause an eventual jump in inflation. QE also implies an even weaker dollar, which, given that America’s trading partners all want to weaken their currencies, could kick off a “competitive scramble towards the bottom”, says Sam Fleming in The Times. Mounting suspicions that the US hopes to default on its external debts by debasing its currency could lead to a sharp dollar slide as America’s creditors, notably China, ditch dollars.
Another possibility is that the printed money lowers bond yields and thus encourages investment in risky assets, producing bubbles. None of these scenarios will fill investors with a “warm and fuzzy feeling”, as Rosenberg puts it – unless, of course, they hold gold.