QE Forever (not Santa!) Is Coming To Town…

The New Santa Ms Yellen!

This Christmas it is looks as if it is not only Santa that is coming to town but also yet another round QE. Yes, you heard it right, literally a few days after the last QE taper ended, talk from the Fed’s Bullard is that there could be a case for more QE. This after a mere 8% routing in the equity market. Gawd knows what they’d do should the S&P actually correct 20%!

The FED is now openly debating the real risk of deflation and laying the blame squarely at Europe’s door due to its lack of growth. Indeed, we are likely weeks away from “Super” Mario Draghi unveiling the first “unsterilised” QE (basically printing money). But the real trigger point is always the same and has certainly nothing to do with unemployment, growth or even inflation. QE is simply indexed to equity market performance, and varies inversely with it. Anytime the market loses traction, the FED will buy assets and it seems that it is willing to proceed that way forever, or until the dollar loses its credibility. Which, in this Alice in Wonderland world is actually at multi-year overbought levels. Go figure that one…

While central banks of old tried to avoid inflation from growing at high rates, I personally cannot find a very good reason why they should avoid deflation at all costs. When we go through a period of excess optimism, demand grows too much, prices increase too fast, and wrong investment decisions are made. When the optimism vanishes demand falls and the economy thus needs to get rid of its excesses. Deflation is sometimes just the way thise process occurs. It doesn’t mean the central bank should stand by quietly but it doesn’t also require the central bank to be super aggressive against deflation.

The true issue that deflation makes it difficult for the government to pay the interest on its debts and also makes bankers unhappy. That’s when the central bank plays its second role, to save bankers and the Government, not its citizens.

Over the last few years we have been force fed by Governments and the Fed on the effectiveness of QE. After three programs, sure the FED has been able to reduce the unemployment rate and lead the US economy out of a deep recession. In fact it seems to be so good that I really don’t understand why central banks in Africa don’t just print money to lead their citizens out of their misery…

While the “good effects” of QE are reflected in high financial asset prices and tweaked economic indicators, the bad effects come in the form of massive wealth redistribution that is changing the face of American society forever. In a report published last Thursday, the Census Bureau showed that there are 48 million Americans in poverty. The middle class is also continuing to with many more people falling below the poverty line. How is that possible? With unemployment now pushed down to 5.9% through QE, why is the economy failing?

There was a time when I learned that financial assets reflect the expectations of future economic growth. The rationale was relatively simple to understand. When the economy grows, more profits are made by companies and so their equity prices rise. In a certain way, equities are a derivative of the real economy. They’re like a call option on real growth. We buy them because we expect the underlying real economy to grow. But central banks think differently. They believe that if they throw enough money at buying calls, they can push the underlying price higher. However, all they can do is to distort the put-call until it reaches a breaking point. At that point, the price of the calls will catch down with the underlying economy and additional call buying is needed. Put simply, QE works as long as it exists and its effects stop as soon as it ends.

A few days after the FED ended its program, here we are again on the brink if starting a new one. We should formally redefine QE as an automatic stabiliser for the financial markets. QE = f(equity prices). That would be really nice. Not even Paul Krugman thought about such a thing!

My final advice goes to the US government and the food stamps program. Please end it now and replace it with an equity stamps program. Just give equities to the poor instead of food. The next day they can sell them and get twice as much food as before.

Filipe R Costa