QE: The Greatest Thing Since Sliced Bread
Quantitative easing (QE), or the Federal Reserve’s bond buying program, has been a spectacular success. Arguably, the greatest innovation since sliced bread. Don’t believe me? I mean, if you listen to many of the experts, strategists, economists, and blogosphere pundits, the magical elixir of QE can be the only explanation rationalizing the multi-year economic recovery and stock market boom. Don’t believe me? Well, apparently many of the bearish pros make sure to credit QE for all our financial/economic positives. For example…
- QE is the reason the stock market is near all-time record highs.
- QE created seven million jobs in the U.S. over the last four years.
- QE turned around the housing market.
- QE turned around the auto market.
- QE weakened the U.S. dollar, resulting in flourishing exports.
- QE has lowered borrowing rates, thereby cleansing consumer balance sheets through deleveraging.
- QE is the reason Facebook Inc. (FB) hired 1,323 employees over the last year.
- QE is the reason Google Inc. (GOOG) has spent $7.8 billion on R&D over the last year.
- QE explains why McDonald’s Corp. (MCD) plans to open more than 1,400 stores this year.
- QE explains why Warren Buffett and 3G capital paid $28 billion to buy Heinz.
- QE is the reason Elon Musk and Tesla Motors (TSLA) invented the model S electric vehicle.
- QE exhibits why Target Corp. (TGT) is expanding outside the U.S. into Canada.
- QE is the reason why S&P 500 companies are expected to pay $300 billion in dividends this year.
- QE is the reason why S&P 500 companies were buying back shares at a $400 billion clip this year.
- QE is the basis for corporations spending billions on efficiency enhancing cloud-based services.
- QE led to a record number of new FDA drug approvals last year.
- QE has caused a natural gas production boom in numerous shale regions.
Wow…the list goes on and on! Heck, I even hear QE can take the corrosion off of a rusted car battery. Given how incredible this QE stuff is, why even consider tapering QE? Financial markets have been volatile on the heels of tapering the 3rd iteration of quantitative easing (QE3), but why slow QE3, when the FED could add more awesomeness with QE4, QE10, QE 100, and QE 1,000?
All of this QE talk is so wonderful, but unfortunately, according to all the bearish pundits, QE has created an artificial sugar high, thus creating an asset bubble that is going to end in a disastrous cratering of financial markets.
I know it’s entirely possible that QE may have absolutely nothing to do with the financial market recovery (other than a bid under Treasury & mortgage backed security prices), and also has no bearing on why I buy or sell stocks, but I guess I will need to hide in a cave when QE3 tapering begins. Although the end of dividends, share buybacks, housing/auto recoveries, acquisitions, expansion, innovation, etc., caused by QE tapering sure does not sound like a cheery outcome, at least I still have a loaf of sliced bread to make a sandwich.
*DISCLOSURE: For those readers not familiar with my writing style, I have been known to use a healthy dose of sarcasm. Call me if you want a deeper explanation.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE II : Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and GOOG, but at the time of publishing, SCM had no direct position in FB, TSLA, MCD, BRKA, TGT, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC
My grandma's retirement funds are doing great because of QE. You know nothing.
This is an over simplification. QE was part of a wide array of structural adjustments, the combination of which led to the economy (somewhat) improving. Also, a large portion of the stock market's increase was simply confidence returning to the market and prices recovering to previous levels. QE made it possible to do this more quickly, but the ultimate reason people are investing is because of numerous other factors such as the (relatively) successful bank bailout program.
As QE slows, so will market value increases. In fact, they might decline a bit as we see some price discovery once the bond market gets a handle on the tapering. The broader focus of the current political administration hasn't necessarily been growth or even juicing the system to get good numbers: it has been stability, and stable growth. This is perhaps frustrating for business leaders who always want more, but in another sense they feel less pressure given they don't have to worry about the boom/bust cycle repeating itself over again. (as opposed to the last administration that seemed keen on actively feeding such a cycle)
There has been growth, for sure, but I wouldn't even say it came from the stimulus package. NOT having a major financial panic for several years allows people to get back to business as usual, and prices recover as a result. During the panic, people drove prices down via selling off, now they have recovered and continue to grow....reversion to the mean, give or take.
It might be accurate to map the trendline of growth in comparison to a moving 10 year average of major indices. Real Growth has been accelerating at a geometric rate, but looking at an expanded index chart shows that we entered a phase of cyclical, bubble driven numbers somewhere in the later half of the 1990's and didn't really emerge from that until very recently.
I like that you can see the positive in this program, however, especially when compared to so many financial 'pros' have been dwellling in a negative state of existential angst because they are too partisan to learn and understand what's happening.
Understood, you make good points.
I just want to clarify one thing: when I say I see equity valuations slowing growth, I don't mean negative numbers. After +/- 20% growth, it may slow to 7% or slower. A lot of the "gains" we've seen are nothing more than prices bouncing back to pre-recession levels plus a few points of actual growth as people stopped thinking the world was going to end. I'm thinking that there are some overvalued stocks, so we're bound to see some price discovery, but the market overall hasn't grown a whole lot....just regained lost ground. Actual growth is much lower than 20%
Hope that isn't worded to sloppily?
Yeah, I think a lot of companies and especially investnemtn banks (see: UBS) realized that they had a finite period of time to make some pretty drastic changes before the gravy train ground to a halt. It's not growth, but ideally a lot of places are positioned for growth. Considering that Democrats aren't typically friendly to business, this is a huge gift LOL
God help us all (including the Economy) when QE ends and interest rates go into hyper inflation.
The philosophy behind Bernanke's monetary policy is actually quite novel; It's not really grounded in traditional, counter cyclical economic theory whatsoever. He has expanded the supply of money while, at the same time, he has instituted measures to keep velocity arbitrarily constricted. The purpose of monetary expansion has always been to increase the supply of money in order to satiate the higher transaction and precautionary demand for money which yield macroeconomic shocks and/or exacerbate the effects of 'real' shocks.
But this is not to say that the multiple rounds of QE has had no effect on the economy. It has certainly been successful in:
To answer one of the OP's questions: the reason why we can't have 100's of rounds of QE is because, though Bernanke has entirely ignored sound economic theory in response to this crisis, he is at least somewhat partially familiar with it. He knows that printing tens of trillions of dollars will, at some point, yield monumental inflation (once the funds enter circulation) and will therefore cause interest rates to spike (which will undo all of the imaginary growth that he has taken credit for). The only question now is, is this going to happen anyway and to what extent?
Monetary injections cannot fix issues in the real economy (a central monetarist principle). It may, at least temporarily, stimulate employment growth as real wages decline, but it cannot turn construction workers into petroleum engineers or laid off credit analysts into computer system analysts or nurses (which is probably why we continue to have long-term, structural unemployment).
@ greg - we've been hearinga doomsday prophesies for almost six years. Put up or shut up.
@ Esuric - I enjoyed reading your post and bookmarked so I can go through it again. Personally, I'd argue that the fiscal 'stimulus' package did more harm of the type you talk about.
My perception is somewhat different and one variable changes the context. The gov't isn't reducing or increasing the total amount of liabilities, just changing the terms. Within the framework of "money being printed" yes, QE would be a doomsday scenario. However, within the context of they're merely changing the terms of enormous amounts of preexisting liquidity, aka freeing it up as opposed to having it locked into an unfullfilled obligation, things change.
As for pointing out that monetary injections don't address structural changes in the economy: exactly correct. The overriding concept has been to keep the actual monetary system itself stable while companies restructure themselves. If UBS is any indicator, this has been happening for some time and the pain has been felt....and now a lot of firms are positioned for longer term growth. The fiscal policy didn't DO that, it ENABLED it given a period of stability. I think a lot of companies said to themselves "we have to change now while we have a chance because when the economy picks up we don't want to be left behind". Had they crawled into fetal defensive positions in a full blown financial system meltdown, they likely would not be thinking this way.
In the big picture of American policy, $80BB is a very small drop in the bucket compared to an annual budget of trillions of dollars. There's one other thing to consider: the fed can also take money out of the system at will. Just as the buyout of a company like AIG was able to be undone when gov't control was no longer needed, the same can be done with the amount of money.
If you'd like to pick this apart, I'd welcome it, this is great mental excercise for me! You're probably one of the better theoretical thinkers I've encountered on this site.
I’m fairly limited on time (I have some work to do), so I apologize if you find my answers unsatisfactory.
So first, I completely agree with you on what monetary policy should look like. Monetary policy should keep nominal variables stable in order to facilitate the necessary adjustments within the real economy. My point is that this isn’t Bernanke’s strategy and that this isn’t what’s happening. His strategy seems to be aimed at stimulating growth within the real economy either directly (referring to real estate investment and construction) or indirectly (stimulating M&A’s, buybacks, R&D or just general activity within financial markets related to fictitious capital accumulation). One of my major points is that any changes in real variables brought about by this policy must necessarily be undone once prices, including interest rates, adjust (which is why I previously referred to it as ‘fictitious capital accumulation’).
I also don’t buy the argument that the FED is merely exchanging one type of security for another. While it is true in a technical sense, it ignores or obfuscates some of the implications of his monetary policy. Exchanging illiquid MBS’s, for example, with high-powered money—even if a portion of those injections are parked at the FED, most definitely constitutes a net increase in liquidity.
Now, to deal with some of your points directly:
Margins will be squeezed to a greater extent once yields begin rising to their natural level. This is especially true for relatively capital intensive industries. So while it is true that input prices have been rising, and that this is undoing some of the windfall profits resulting from monetary injections, you’re ignoring one major cost that will inevitably rise.
The issuance of government debt is the supply side. The demand side is being propped up by monetary policy either directly (open market purchases) or indirectly (investors looking to make quick capital gains by selling their notes + bills back to the FED).
Agreed
Okay
Referring to the fact that these institutions have been declared ‘too big to fail’ and the implications that this designation has on incentive structures/appetite for risk. The government is trying to counteract this through tougher regulations but this (a) only hurts smaller institutions and (b) assumes that government regulators can outthink and out step financial industry experts and professionals.
Well this begs the question, namely, were equity values inflated before the recession, i.e., did they reflect true net asset values? Should we support growth in equity markets for the sake of growth or do we think that stock prices should reflect something real about the financial constitution and condition of a firm/the market?
The FED can try to withdraw the reserves from the system but I don’t see how they could do this successfully. A mere hint of tapering sends yields rising; what would the bond market look like if the FED announced mass sales? Prices would collapse—the FED would have to sell a much higher quantity just to withdraw those reserves and this would clearly have a devastating effect on yields.
But all of this is really just a secondary concern. The major issue here, and it’s something that’s rarely discussed, is that Bernanke’s monetary policy has made rational economic calculation next to impossible. How can you determine the true cost of capital/opportunity cost in these conditions? How can investors gauge the real risk-adjusted return on their investments? In other words, how does one determine what a ‘correct price’ is in an environment where nominal variables are continuously shifting due to exogenous policy decisions?
NOTE: some would say that it isn’t really an issue since you can just include the CPI into your calculations or looks at TIPS, but that assumes that the monetary injections are having a proportionate effect on prices. I fundamentally disagree with this—it is undoubtedly yielding structural asymmetries.
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