QE4Ever

A bit like love, eh?

This article offers some good insights into monetary manipulation. The one thing I see missing is the recapitalization of assets based on depressed long-term interest rates, which is a result of Quantitative Easing and Zero Interest Rate Policy (ZIRP). So we have massive asset bubbles across many real asset classes as a result. No one seems to have any idea how this unwinds, but unwind it must.

‘Quantitative Easing’ Isn’t Stimulus, and Never Has Been

By Ken Fisher, RealClearMarkets

(AP Photo/Jose Luis Magana)

Upside down and backwards! Nearly 13 years since the Fed launched “quantitative easing” (aka “QE”), it is still misunderstood, both upside down and backwards. One major camp believes it is inflation rocket fuel. The other deems it essential for economic growth—how could the Fed even consider tapering its asset purchases amid Delta variant surges and slowing employment growth, they shriek! But both groups’ fears hinge on a fatal fallacy: presuming QE is stimulus. It isn’t, never has been and, in reality, is anti-stimulus. Don’t fear tapering—welcome it.

Banking’s core business is sooooooo simple: taking in short-term deposits to finance long-term loans. The spread between short- and long-term interest rates approximates new loans’ gross profit margins (effectively cost versus revenue). Bigger spreads mean bigger loan profits—so banks more eagerly lend more.

Overwhelmingly, people think central banks “print money” under QE. Wrong. Very wrong. Super wrong! Under QE, central banks create non-circulating “reserves” they use to buy bonds banks own. This extra demand boosts bond prices relative to what they would be otherwise. Prices and yields move inversely, so long-term interest rates fall.

Fed Chair Jerome Powell and the two preceding him wrongheadedly label QE stimulus, thinking lower rates spur borrowing—pure demand-side thinking. Few pundits question it, amazingly. But economics hinges on demand … and supply. Central bankers almost completely forget the latter—which is much more powerful in monetary matters. These “bankers” ignore banking’s core business! When short-term rates are pinned near zero, lowering long rates shrinks spreads (“flattening” the infamous yield curve). Lending grows less profitable. So guess what banks do? They lend less! Increase demand all you want—if banks lack incentive to actually dish out new loans, it means zilch.  Stimulus? In any developed world, central bank-based system, so-called “money creation” stems from the total banking system increasing net outstanding loans. QE motivates exactly the opposite.

Doubt it? Consider recent history. The Fed deployed three huge QE rounds after 2008’s financial crisis. Lending and official money supply growth shriveled. In the five pre-2008 US expansions, loan growth averaged 8.2% y/y. But from the Fed’s first long-term Treasury purchases in March 2009 to December 2013’s initial taper, loan growth averaged just 0.8% y/y. After tapering nixed the nonsense, it accelerated, averaging 5.8% until COVID lockdowns truncated the expansion. While broad money supply measures are flawed, it is telling that US official quantity of money grew at the slowest clip of any expansion in history during QE.

Now? After a brief pop tied to COVID aid, US lending has declined in 12 of the last 14 months. In July it was 4.7% above February 2020’s pre-pandemic level—far from gangbusters growth over a 17-month span.

Inflation? As I noted in June, it comes from too much money chasing too few goods and services worldwide. By discouraging lending, QE creates less money and decreases inflation pressure. You read that right: QE is disinflationary. Always has been. Wherever it has been tried and applied inflation has been fried. Like Japan for close to …ah…ah…ah….forever. Demand-side-obsessed “experts” can’t see that. But you can! Witness US prices’ measly 1.6% y/y average growth last expansion. Weak lending equals weak real money growth and low inflation—simple! The higher rates we have seen in recent months are all about distortions from lockdowns and reopenings—temporary.

The 2008 – 2009 recession was credit-related, so it was at least conceivable some kind of central bank action might—maybe kinda sorta—actually help. Maybe! But 2020? There was zero logic behind the Fed and other central banks using QE to combat COVID. How would lowering long rates stoke demand when lockdowns halted commerce?

It didn’t. So fearing QE’s wind-down makes absolutely no sense. Tapering, other things equal, would lift long-term rates relative to short rates—juicing loans’ profitability. Banks would lend more. Growth would accelerate. Stocks would zoom! Almost always when central banks try to get clever they wield a cleaver relative to what they desire.  A lack of FED action is what would otherwis be called normalcy.

Fine, but might a QE cutback still trigger a psychological freak-out, roiling markets? Maybe—briefly. Short-term volatility is always possible, for any or no reason. But it wouldn’t last. Tapering is among the most watched financial stories—has been for months. Pundits over-worry about it for you. Their fretting largely pre-prices QE’s end, so you need not sweat it. This is why Powell’s late-August Jackson Hole commentary—as clear a statement that tapering is near as Fed heads can make—didn’t stoke market swings. The ECB’s September 9 “don’t call it a taper” taper similarly did little. Remember: Surprises move markets materially. Neither fundamentals nor sentiment suggest tapering is bear market fuel.

Not buying it? Look, again, at history. The entrenched mythological mindset paints 2013’s “Taper Tantrum” as a game-changer for markets. Untrue! After then-Fed Chairman Ben Bernanke first hinted at tapering back in May 2013, long-term Treasury bond prices did sink—10-year yields jumped from 1.94% to 3.04% by that yearend. But for US stocks, the “tantrum” amounted to a -5.6% decline from May 21 through late June—insignificant volatility. After that, stocks shined. By yearend, the S&P 500 was up 12.2% from pre-taper-talk levels. Stocks kept rising in 2014 after tapering began. 10-year yields slid back to 2.17%. My sense is even tapering’s teensy impact then is smaller this time because, whether people consciously acknowledge it or not, we all saw this movie before.

Taper terror may well worsen ahead of each coming Fed meeting until tapering actually arrives. Any disappointing economic data will spark cries of “too soon!” Tune them down. History and simple logic show QE fears lack the power to sway stocks for long.

Ken Fisher, the founder, Executive Chairman and co-CIO of Fisher Investments, authored 11 books and is a widely published global investment columnist.

Preparing for the Apocalypse?

end-is-nigh

Federal Reserve policy must seem pretty arcane to most people, which is why I try to liven it up with a bit of sarcasm and wit. There was a lead article in this week’s Barrons illustrating how the public equity markets are shrinking (instead of the Wilshire 5000, it’s now the Wilshire 3666). Here is the lead-in:

As companies find other ways to raise cash, number of U.S. stocks keeps shrinking.

The writer then summarizes an explanation:

Why has the universe of investible U.S. stocks shriveled so? Globalization, porous borders, and the rise of foreign markets have siphoned away a few U.S. listings. Mergers and bankruptcies have exacted a toll. Increased regulation and the climbing costs of a public listing have weakened the resolve of managers who once dreamt of ringing the opening bell at the New York Stock Exchange. At the same time, zealous private-equity buyers and zero interest rates are making it all too easy for companies to raise money without going through the pantomime of public compliance.

This should really surprise no one who’s aware of the impact Fed policy has upon the structure of our economy. Think about it: you start a business with a little capital saved up. If you’re successful and your business grows you need more and more capital, either from the bank, from venture capitalists, private equity firms, or public equity and credit markets (by issuing stocks and bonds). The costs of these different financing options varies. Borrowing at a reasonable or low rate allows one to retain the equity and leverage the profits and value of the enterprise. (This is how one gets into the 1%)

However, if borrowing is dear, growing firms will use public equity markets to spread risk and give up a proportionate amount of return. But Fed policy over the past 20 years has essentially assured business owners that monetary policy will serve to prop up business and equity values with limitless liquidity. That’s what the Fed’s Zero Interest Rate Policy does by keeping interest rates low. (Quantitative easing buys up bad mortgages from the banks so they can get back into the business of making loans, but who wants to make loans when you can make risk-free returns by buying Treasuries and lending to the government?)

So where’s the risk and the imperative to give up equity profits to share that risk? Essentially, the Fed has given businesses and speculators free insurance and leveraged them up with cheap credit. The taxpayers provide the guarantees by absorbing any losses with bailouts.

So, as the article explains, we see private equity and share buybacks shrinking the participation of the public in the profits of capitalism. Why give up equity if there is no risk? It is my opinion that Fed policy is accelerating the imbalances in our market society to unsustainable levels. And the politicians merely think the headline numbers show what a great job they’re doing. The Obama administration is touting the bubbling stock market as proof of how great their policies are working for America. Really? They should think about this: a permanent zero or negative real interest rate essentially means There. Is. No. Tomorrow. Great, shall we call it the Apocalypse policy?

apocalypse2