Farewell QT, rest in peace
They had us worried there. If only for a moment.
America’s new head of the Federal Reserve, and the outgoing Mario Draghi at the European Central Bank (ECB), had promised the world tighter monetary policy.
QT, they called it. Quantitative tightening instead of the quantitative easing we got used to.
The trouble is, it turns out QE is addictive. It’s hard to wane yourself off monetary stimulus once you’re on it.
Each time the central bankers tried to tighten monetary policy, all hell broke loose. The taper tantrum, October’s plunge in stocks and instability in the European bond market in May are examples. Lately, even the world economy has turned down. GDP growth is slowing all over the place.
So the central bankers have given up on QT. And turned back to QE instead. Phew.
Satyajit Das, a former speaker at our conference in Sydney, summed up the reversal in Bloomberg: ‘Just since December 2018, central banks have collectively injected as much as $500 billion of liquidity to stabilize economic conditions.’
So much for QT… We hardly knew you.
The consequences are on show, too, according to Das:
‘The U.S. Federal Reserve has put interest rate increases on hold and is contemplating a halt to its balance-sheet reduction plan. Other central banks have taken similar actions, fueling a new phase of the “everything bubble” as markets careen from December’s indiscriminate selling to January’s indiscriminate buying.’
Yes, indiscriminate buying! Who cares what happens — buy everything! After all, more money floats all boats. Just as a lack of money sunk them in late 2018.
But wait a minute. QE was supposed to be over months ago. We were supposed to be well into QT by now. What happened to those charts of shrinking money supply? Instead, we got the opposite, starting in December.
All it took was a stock market shock and a bond market wobble for central bankers to change their minds.
Understanding what happened is crucial for investors. Because central bankers are the key to the markets now.
How much they print moves markets. When they’re expected to stop printing signals when markets will drop. Now you can add a third indicator: You need to guess how bad things need to get for them to return to printing. When do markets start to go back up?
December’s market plunge gave you your answer.
Central bank tightening is already over
But what exactly did happen to QT? Why did it never really take hold?
There are plenty of theories on that.
Sub-prime crisis predictor Peter Schiff recently explained to an audience that President Trump’s tax stimulus was like a defibrillator shock on a long dead body (the American economy).
Schiff hadn’t expected anyone to be dumb enough to try Trump’s tax policy, so he didn’t see the subsequent interest rate hikes coming either. He’d predicted the Federal Reserve wouldn’t manage to raise rates much, if at all.
But it did manage to hike rates quite a few times, thanks to Trump’s tax bump. American monetary policy was tightened significantly. But Schiff argued the American central bank was too keen to see the economic upswing from Trump’s policies as the sustainable recovery it had been predicting for almost a decade. So it raised interest rates too far too fast.
Now that the economy has settled back down to being dead again, the rate hikes look like a really bad idea. That’s why markets plunged in October. And why the Fed has paused any more hikes.
Another theory says that the world is just entering a long awaited downturn. Economic expansions only last so long. And we’re on borrowed time after an impressive run.
But Satyajit Das said it best in his Bloomberg editorial. Central bankers were once supposed to be lenders of last resort. Not anymore.
‘Instead, they’ve become lenders of first resort, expected to step in at any sign of problems. U.S. central bankers are currently debating whether quantitative-easing programs should be used purely in emergency situations or more routinely.’
The world is turning Japanese — an economy reliant on government and central banks to keep ticking over. What once was an emergency power is now standard policy.
The moral hazard economy
Years ago, I called the shifting expectations people have of central bankers ‘mandate creep’. It’s part of every other government policy too.
To show you what I mean, try and remember the topic of conversation during the bank bailouts of 2008. We used to discuss the problem of moral hazard in the following way: If banks know they’ll get bailed out, they’ll take on excessive risks. That leads to bigger crises in the end.
These days, we have an entire economy running on moral hazard. Every borrower thinks their central banker will bail them out with lower interest rates. Every investor thinks they’ll be rescued by QE if markets fall.
There is no longer any potential downside to financial decisions. At least, it’s limited to a drop in stock markets the size of October and November. Then central bankers come back in to rescue us.
Financial markets and the economy have turned into a gigantic punt on the power of central banking. Nothing else matters.
Is that irrational or wrong? I’m not so sure. What is the limit to a central bank’s power? Do you want to bet against that power? I suspect it’d take a very long time to be proven right.
For a moment, think about the premise we’ve lost in all this. If governments and central banks can’t spark a self-sustaining recovery with their ‘temporary’ policies, do they still have legitimacy?
How will politics perceive central bankers running the world indefinitely instead of in the short term? If we realise the medication we’re taking is addictive, what do we do? Take more?
I don’t know the answers to those questions. But I do know the answer to the question you should be asking instead: What should you do in the face of all these questions?
Where to put your money in a QE world
First things first: Don’t rely on central bankers getting things right. As you read this, an impressive housing bubble is inflating in Germany and the Netherlands. Those economies are the Spain and Ireland of 2005. Eventually, the bubble bursts. But that could take time.
Instead of relying on central bank policies, play them and their unintended consequences. Buy a German house, invest in stocks and don’t expect a financial crisis anytime soon.
With another portion of your capital, opt out. Central bankers can’t manipulate and control everything. Some assets are non-financial.
Gold is the asset that outperforms during artificially loose monetary policy — which is what we’re in for indefinitely. And it’s the asset you want to own during a banking crisis, too. Because it’s not part of the financial system.
One last thing. There is one place in the world where central bankers can’t paper over problems for long. The ECB’s powers are limited, unlike other central banks. So that’s where the next true crisis will come from. It’s the lack of a rescue that’ll be devastating, not the outbreak of a crisis.
Until next time,