I hate the phrase quantitative easing, it is a bit like calling an apple, Malus Domestica-Borkh. But QE is no apple, it is a rigged game as far as investors are concerned, and the Fed is playing on the market’s irrationality, and its passion for the short term, to pump a little more blood into the valves.
As an economist who went to a monetarist university, I was taught that the supply of money cannot not impact long term real economic relationships, merely facilitate them, but I do believe that past money supply excesses can significantly impact current relationships, either through inflation or through deflation (in particular asset price/debt led deflation).
Deflation is the killer though, because in a fractional reserve banking system you only need a certain amount of debt defaulting to make it insolvent. And of course, the fractional reserve of the asset market is the portfolio’s % allocation to cash: small changes in preferred cash holdings create large % changes in the valuations of risky assets. We no longer know just what is the real risk premium, but by pressing “lower risk” rates down, the Fed is flaunting the margin. In truth asset prices in this context cannot be the bargain they are made out to be!
Whereas inflation occurs when the supply of money allocated to expenditure exceeds the value of a given level of output, and prices adjust to bring both into equilibrium, debt led deflation is where the value of assets, and the money needed to repay debt used to fund those assets, is beyond that capable of being financed by long term real output growth. This is a situation made worse by a distribution of income inequality at odds with debt distribution. In this case, the level of debt, the price and/or supply of assets need to adjust downwards to bring the equilibrium output in line with the real value of assets.
Deflation, in my opinion, is by the far the worst risk, because by the time you are experiencing the consequences the damage has already been done and only time and price/debt and supply adjustment can reverse the impact. We are not experiencing a pure monetary phenomenon and this is why QE is not working as intended.
Bernanke failed to see the extent of the debt build up in the decade or more to 2007, and especially, the asset focussed debt build up which increased the deflation odds considerably. He is now paying the price for this error. In debt led deflation QE is mostly only paying for time!
I doubt very much whether Bernanke can afford to care much about savers and investors, because saving the financial system is his priority. Someone has to lose in order for a sensible economic balance to re-establish itself, and if QE is largely playing for time, then it is the time value of investment return that will ultimately be one of the key adjustment factors.
At this stage of the game, Bernanke has too much invested in this particular solution to be able to adopt an alternative game changer – the Federal Reserve and the Federal Government are too far in too pull out with most of their ammunition already spent. The other options have been crowded out.
In truth, the problem is not really one of too little money supply, it is too much debt and a global and domestic distribution of wealth and demand that is about as back to front as you can get.
QE does not put money into the hands of consumers for consumption: the monetary base has already expanded faster than at any other time in history, but then again so has the supply of sovereign debt. It has replaced both private and institutional investors bond holdings with cash and little option to hide this negligible return amongst cash based investments.
The problem is that real economic output is not at a sufficient level, or sufficiently distributed, to encourage consumption by private individuals and corporate investment in capital (both human and machines), and expectations of output growth and returns on human capital and capital investments are also likewise low. Real incomes and real output need to expand considerably, for a reasonable amount of time, for expectations to be affected, therefore it is most likely that a fundamental economic factor will lead the US and global economies out of trouble, as opposed to a monetary one.
The extra cash injected into the system is needed to make sure that the portfolio allocation to cash is reduced in favour of risky assets. Low returns on cash and higher returns on risky assets should a) force investors to push up the price of risky assets, and with markets a traditional barometer of economic health, raise the confidence of individuals to consume and employers to invest in capital, b) force banks to lend, c) forced companies to invest excess cash or return it to shareholders. Money needs to be moved around faster.
But, while it only takes a small shift in the market’s preferred portfolio allocation to cash to push equities forward, banks, consumers and corporations often need more solid proof that they can spend, lend and invest. After 5 years the weight of evidence is on the side of caution.
But we face a more intractable problem: while the rate of growth of economic output is constrained by many factors (wealth distribution, global imbalances between consumption, saving, investment and production, high unemployment, declining returns on capital investment and others), the US economy is about to hit the fiscal financial wall as many in Europe are now experiencing.
The current rate of growth US government debt (both at the Federal and State level) cannot be supported by current domestic and international growth rates.
If current economic problems were only the result of short term reaction of consumers and businesses to the financial crisis, and all that was needed was a boost in confidence to shock the economy back it into its normal spending patterns, then QE would work. But these are not the problems, and QE is faced with a myriad of problems and objectives that have effectively soaked up its intended impact.
US consumer expenditure is still too big a component of US GDP, US government transfers make up far too big a component of national income, much of employment growth has been centred on too narrow a sector, unemployment remains far too high, savings rates too low, returns on lower risk assets incapable of funding retirees expenditure plans and the government and central banks have all but come to the end of what they can do to foster a balanced economic recovery. China has failed to ignite and is itself still too dependent on infrastructure investment, the returns from which lie beyond the current crisis, and Europe is in an economic shakedown.
Current QE measures after a 5 years of crisis smack of desperation. We are about to to slip below escape velocity, a rate of growth from which there is no monetary escape.