Icebergs ahead! All head full!


Ben Bernanke will soon be announcing yet more “large scale asset purchases”. This is all part of Quantitative Easing – part deux or QE2 as it has become known (I really do object to that name).

The purpose of QE2 is to put a stop to any threats of deflation and bring down unemployment. This is fine in theory but back in the real world a tad more problematic. I have yet to be convinced that Benny boy has thought through all this as carefully as he should have done. There is no real proof that any of QE2 will have any positive impact on the economy at all and it seems that no consideration has been given to any long term effects that could well happen because of this rather weird strategy. Investors have already bid up asset prices as they are confident the Fed will be its usual generous self.

Despite many having misgivings, most people agree that the first lot of Quantitative Easing a couple of years ago did actually work albeit not as well as people hoped. The markets responded accordingly and global meltdown just did not happen. However, the problem is that things are not the same as they were in 2008. The credit system is not up that well known creek without a paddle, financial institutions are willing to lend – granted on a much stricter basis than before. The problem is not that money is not there to lend, it is that there are very few people to lend it to as private companies do not seem to want to saddle themselves with more debt.

Given this, it does seem daft that much of the new money being printed and thus expanding its balance sheet could well just end up being thrown on the present mountain of more than USD1,000 billion of excess reserves that are in the banking system at the moment.

Another great myth about QE is that it is intended to reduce unemployment. Given that the US announced at the beginning of December that almost ten percent of the workforce was unemployed it is hard to see how politicians can make this statement. The common man is having to work twice as hard to find a job and often it is for less than he would have accepted a few years ago. Their future is not going to get better by the Fed buying up Treasury Bonds.

Some people talk about the continued advantages of having exceptionally low interest rates. Yes, this is good in certain respects but given the massive plunge in price of the western property market many homeowners are now in the situation where they owe more than the house they bought is actually worth and so cannot refinance anything to give themselves the necessary kick-start. Also, as long term interest rates in the much of the west are so low, QE is not likely to get in much new business investment.

I have to say that, like many economic commentators, I do not understand Ben Bernanke’s problems when it comes to deflation. There is no deflation in America. In is also up for discussion whether a mild amount of deflation is actually damaging. Even if it was then nobody really knows if mass asset buying by the Fed inter alia would reverse the trend towards deflation.

Any economic historian (and gourmand!) will tell you that after one has stuffed oneself then the purge has to happen or, to put it another way, once you have maxed out all your credit then you have to buckle down and start to pay it off. Deflation is a reflection of this and is not a cause but a symptom. Japan is a perfect example as it shows that deleveraging does not mean it is all over just because long term interest rates decline. This is why the Bank of Japan believes QE to be a waste of space these days.

The hope of Mr. Bernanke is that if asset prices get a leg up then consumers will spend more but this just means that people will save less and so the downward spiral will continue – this at a time when America’s net savings rate is already negative. The country, indeed the whole of the western world needs to save and then invest more so as to guarantee its long term future. QE is a big threat to this as it puts off what needs to be done now.

It does not end here. QE will definitely affect fiscal spending. The finances of the western world are, to put it mildly, not what they could or should be. This year, the American fiscal deficit will be nearly ten percent of GDP. With US banks printing money like it has gone out of fashion this will only get worse as there will be little or no discipline exerted to rein things in.

QE will also be used to massage household balance sheets. This means that asset prices will be distorted and anything which could look like a bubble will be inflated (please forgive the pun!). As QE2 has been talked about more and more, people have gambled on assets that are more than a tad risky with the price being extended. Stocks in the west are, generally, offering low returns and many Treasury bonds are way over-valued.

All of this means that the central banks may do what they want in being able to fool all the people all of the time but this will not go on forever and those fooled will realize they have been had with over-valued asset prices. They may have been tricked into buying things now so as to improve their balance sheets but they will have to pay the repercussions tomorrow.

QE, though, does not just affect America and the rest of the western world; its ramifications are global. The US Dollar has weakened as money has headed eastwards where they have better yielding currencies. This may sound good but these emerging market countries have had to buy the US Dollar so as to stop their own currencies appreciating. They do not want to do this but have had to. The problem is that when a country or countries get involved it can weaken the monetary situation of a nation, especially an emerging one, and so lead to inflation and asset price bubbles. This is the reason that some countries are thinking about bringing in capital controls.

So, does any of this matter to you and I? Yes, absolutely. Whilst we have been listening to the smooth sales talk of Bernanke and his cohorts the ship we are on is not the QE2, it more resembles the Titanic steering straight for that iceberg. So as to prevent any permanent harm to your finances – keep liquid.

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Graham Macdonald on [email protected]