QE, for the Sake of…It
They told you it was temporary…reversible…for emergencies only…
But nothing is as permanent as a temporary government program. And now QE is back, big time. Just as it did in the past, it’ll change the investing landscape dramatically.
Have you changed how you invest yet?
How? I suppose I better explain why first…
Over at the European Central Bank, they’re creating 20 billion euro a month to buy bonds. The US’ Federal Reserve is busy too, although their latest intervention isn’t technically classified as QE. But it still increases the money supply. The Bank of Japan’s long running QE continues unabated too.
As I pointed out last week, QE is even on the table here in Australia. The only place they haven’t floated the magic money tree is Brexit Britain…
That’s the state of things now. But to grasp what I want you to realise today, we need context.
Before 2008, QE was something Zimbabwe did. But it became an emergency policy to reliquidate the banking system in 2008.
Then it became a way to boost asset prices to encourage the ‘wealth effect’.
Then it became about encouraging more debt, which central bankers consider to be synonymous with economic growth.
Then QE became a way to improve the overall economy. But it didn’t.
Then a way to bail out governments, which it did, but which is also illegal in most monetary jurisdictions.
Then a way to push inflation even higher, which failed. The only place with high inflation these days is the QE-less UK.
So what’s the latest reason for the new QE at the ECB and Federal Reserve?
Has a bank failed? Is inflation dipping below 0? Are GDP figures hitting recession levels? Is unemployment rising?
Has anything at all gone wrong?
Not really. And yet, new bouts of money are flooding off the digital printing presses and into economies. For the sake of it.
This is a deep and radical change to the nature of monetary policy, if you ask me. It looks like central banks have altered their strategy. From being ‘data dependent’ to a pre-emptive strike doctrine.
Papering over problems is one thing. Pumping more money into the economy to avoid any problems in the first place is quite another.
QE is now the default position of monetary authorities around the world. Short of a miraculous economic recovery, or QE actually working, you can expect QE to go to infinity.
The most interesting angle in all this is what it means for investors like us. What does a world with QE, but no reason for it, look like? How will it impact asset prices?
The good news is, we have past lessons to guide us. It’s not like QE is entirely new at this point…
But before we dig into predictions, notice another thing about QE which has changed. Until now, the most important monetary authorities of the world took it in turns to implement QE. They rarely expanded their balance sheets all at the same time.
Yardeni Research’s chart, which shows the central bank assets of the US, eurozone, Japan and China, is a confusing mess. But notice how the various central banks expanded at different times?
Source: Yardeni Research
At any given time, while some were pumping money, others were holding off.
Well, they’re about to embark on a period of synchronised expansion, as far as I can tell. At a time when there’s no reason to do so, don’t forget.
What do investment markets do in this environment?
All sorts of strange things…
The first lesson we can learn from past QE periods is simple. Don’t expect QE to lead to inflation. It simply hasn’t. Why is another topic for another day.
Inflation, as we know it, may not appear. But all that money does flood somewhere. Asset price inflation is what we’ve been calling it for years. Stocks, bonds and commodities are bid up. Financial assets, but especially real assets like gold, surge in value. The rich get richer.
Do you remember the ‘good news is bad news’ games? They are held during QE periods. Because good news suggests less QE and bad news suggests more. This means you shouldn’t invest based on optimism, but pessimism…
Another interesting feature of the age of QE is the lack of default risk from governments. Central banks tend to implement QE by buying government bonds. This finances government deficits, however indirectly. Default risk is significantly less likely. In most places, anyway.
Shortly after the ECB announced its QE, the Greek government managed to sell its government bonds at negative interest rates. Investors paid a country which defaulted only a few years ago for the opportunity to lend it money…
Last but not least, don’t sit there waiting for things to resolve themselves, for a return to normality. QE creates all sorts of problems for economies. This is a deep-seated crisis that may well last your lifetime.
Learn to invest in the age of QE.
Until next time,