The success of the QE measures rolled out by the Fed over the last five years can be debated until the cows come home. For some, they have been the biggest peace time boon to their net wealth in history. To others (90%+) it has been of no discernible overall benefit aside from debtors with mortgages enjoying an artificially suppressed interest rate, and to some it has been a disaster (the poorest through price inflation – irrespective of what the Gubermint stats tell you!).
The primary goal of the QE (and indeed all monetary) policy is always to drive real growth in the economy. Through the mass purchase of assets in order to bring about a decrease in real interest rates and the commensurate reduction in the cost of money and credit, the central bank expects investors to decrease their demand for safe assets and seek out riskier ones. Asset prices increase, and through the wealth effect, real investment grows in the economy. This connection with the real economy is imperative for the effectiveness of QE.
Understanding the effectiveness of QE has been the goal of many academics and practitioners over the last few years. However, such a bold plan on a coordinated sale that has been QE is pretty much unprecedented. We will very likely have to wait to measure its real long-term effects. But while effectiveness is indeed an important perspective, we should not forget about other perspectives that should always be taken into consideration.
If financial assets are held by the population in proportion to their income level, when asset prices rise, all benefit to the same relative extent. But if these assets aren’t held proportionately, a redistribution of wealth may occur. In fact, we know that the bottom 40% of the population spends 104% of their real disposable income on non-discretionary items and won’t probably have a single dollar invested in financial assets. Only the wealthiest households own equities, and only they will directly benefit from QE. In this sense, QE will actually lead to an increase in the gap between the rich and the poor. Of course, the Fed expects higher asset prices to lead to higher investment levels, to the creation of spare capacity, and to the creation of jobs, which would then feed through to the income of all other households. But the recent trends in growth cast serious doubts over that assumption.
One important measure we can look at is real disposable income. Is it growing as a result of QE? In a letter to investors which aptly summarises the situation, Eric Sprott from Sprott Asset Management made the following comments about real disposable income:
“If one looks past headline figures, things are not really getting better. As shown in Figure 1 (shown below), real disposable income per capita in the U.S. has increased only modestly since the Great Recession. However, all of this increase is due to Government Transfers, not from an improvement in the real economy. If we exclude those transfers from the numbers, disposable income per capita is actually lower than it was at the end of 2005 and has been painfully flat since 2011.”
So, the modest rise experienced in disposable income is a consequence of an active fiscal policy, through which the government transfers funds to households. Without these transfers, real disposable income would have decreased between 2005 and 2012.
The gap between real disposable income when including and excluding government transfers has been increasing, with households ever more dependent on these transfers as a source of disposable income. This is not good news regarding Q. I effectively means that the mechanism may be broken and its effects aren’t permeating throughout the economy.
What is worse, is the fact that inequality is increasing. The average annual after-tax income for the bottom 20% rose from $9,220 in 2005 to $10,171 in 2012, a rise of 10.3%. For the next 20%, the rise was from $25,200 to $27,743, corresponding to 10.1%. But for the top 20% the rise was around 14% to a level of $158,024.
Another worrying sign is that the bottom 40% spend 40% more than they make. That’s right! Their income isn’t enough to face their expenses and they need to sell assets, to borrow, and to receive assistance from family, etc. Such a situation is worrisome, especially as it has been deteriorating over time. For this group, between 2005 and 2012, income rose 8% while expenses rose 14%. Needless to say, this is an unsustainable situation. Another bad sign is the fact that this group spends 104% of its income on non-discretionary items.
A few years after QE started we see inequality growing and 40% of the population not even able to pay for their primary expenses. With no money left for discretionary consumption and with the richest not aggregately investing in the economy, the effects of QE are limited to the inflation financial assets… and when financial assets grow without accompanying growth in the real economy, we are in, yes you guessed it, a bubble.
Filipe R Costa