Sunday, 16 September 2012


Here we go again! Less than two years after the launch of QE2 the Federal Reserve has announced a new round of monetary easing. This time the quantity and time frame of the bond buy-up programme are unbounded. Would it lift the ever-ailing US economy? I seriously doubt it.

Let’s face it, the economy of the United States has seen better and worse days since 2008. Despite near-zero interest rates and two completed rounds of injecting ample liquidity into the banking system, economic growth is brittle, labour market shows little signs of improvement and housing market, which quite probably bottomed out is still in a slack, as access to credit stays tight. The very last factor, as I have pointed out many times, foretells the ultimate failure of the QE programme.

Quantitative easing basically consists in changing structure of commercial banks’ assets by the central bank. The Fed buys government bonds (mainly those with longer maturity, thus exerting pressure to move down to long end of the yield curve, which in turn relieves mortgage debtors) from commercial banks and changes them into cash. This means banks have more liquidity that can, theoretically, be used to grant loans to businesses and households. This does not happen, as banks keep restraint in lending, which they perceive risky and additional cash is goes into financial markets where it pushes up price of risky assets such as equities, commodities and currencies of emerging markets.

According to theory of economics, increased money supply, the direct consequence of the QE, should, holding everything else unchanged, give rise to inflation. This has not happened, as the new money does not flow into real economy, but is diverted into artificial financial markets. If the above holds true, does the real economy benefit from the QE? I uphold my theory Mr Bernanke again favours speculators betting on financial markets over non-financial businesses and households. The QE3 might peter out and then he may launch another QE4, QE5, …, QE100 and extend the balance sheet of the central bank he governs until the end of the world and keep helping the US government financing its mammoth debt, but without solving structural problems of the US economy, he is going to attain nothing, except for gratitude of bankers. I could call for further deleveraging, turning the savings rate positive, switching from imports to domestic production, tax reforms and other moves that would change the distribution of income between the poor and the rich. The cradle of modern capitalism is no longer the country where you can grow from rags to riches. Once you are born as the underclass, you are very likely to die as the underclass…

Recent action of the European Central Bank are not such a crying shame, but cannot be deem commendable though. The key institution of the monetary union announced it is conceivable the ECB would buy up on secondary market bonds issued by distressed eurozone governments. Technically the PIGS bonds would be swapped for money market bills issued by the central banks. Here no new money flows into the financial systems, so the beneficiaries of the operations are commercial banks, which have a better credit quality of assets and distressed governments, as yields on their bonds go down. The move does not solve any structural problems of economies under water, it only defers their ultimate collapse, which still looms unavoidable.

To explain the results of both programmes run by central banks we have to invoke the mechanism of self-fulfilling prophecy. If market participants expect the Fed pursues QE3, they believe the money is not injected to real economy, but into financial markets, as it always used to be. Consequently, their inflation expectations do not change and consumer prices do not go up, but they expect prices of risky assets to increase, so they buy them to profit from the uptrend and bring about a bull market on risky asset markets. I was once told not to play against the Fed, but this time I would not dare to put my money into equities. Stock prices hinge upon macroeconomic fundamentals; fragile as they are know, they will sooner or later drag them down, despite excess money on the market. If market participants believe the ECB would buy up junk bonds of PIGS countries, they would be more eager to purchase them on primary markets. This will surely help these government stay afloat, but still does not solve structural problems underlying economic miseries.

Plus note all actions of central banks do not affect confidence among consumers and companies. Both are reluctant to spend money for consumption and investment purposes as they fear lean times, so they do not generate demand on products and services…

Many economists claim 2013 will bring another economic disaster – recession in the eurozone and in the United States, Greece being ousted from the eurozone, severe slowdown in China and in Poland. Whatever happens, we have to live through it and draw lessons from it. What central banks do, apart from its moral aspect, i.e. fostering financial institutions interests, is essentially sweeping the problems under the carpet, by giving temporary relief. And the longer you do this, the larger the hill of rubbish under the carpet grows…

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