Sunday, December 01, 2013

A Non-Economist View Of QE

We are now trapped into a vicious cycle of quantitative easing, mainly by the EMU and Federal Reserve. Even the hint of tapering seems to shock the markets into a tailspin. Then we have the rising share prices and property prices almost globally, and when each country tries to pull the handbrakes on property prices, the developers complain that its not their fault, its the QE stupid!

a) USD/Euro devalues - For every dollar/euro that is printed, the existing dollar or euro gets depreciated a little as these are technically not backed by anything, they just roll off the printing press. It is HIGHLY UNLIKELY that the Fed or EMU will be buying back all the notes they have printed, that's a given. 

b) The Bastardisation of Currency - Gold went on a tear as that was said to be the best keeper of value in an era of drastic bastardisation of real currencies. When it is printed by a small country, you can be assured that the currency will be devalued almost immediately. However, the situation is a bit different with the top two currencies plus the yen getting into the picture albeit a bit late. Can you, will you technically devalue these currencies? These three currencies can get away with a lot of indiscretions. Most central banks keep large amounts of these three currencies as a way to build up reserves to shore up confidence for their local currency. In a big way, the smaller developing countries are subsidising these heinous acts by the 3 major central banks.

c) Inflation, What inflation? - All things being equal, the amount of QE should have, would have seen a much larger circulation of funds chasing after the same amount of goods, services and assets. But inflation has been benign for most countries. Much of the QE funds reside with the big banks which basically get cheap funds, but do not lend the same amount out. It is safer and more profitable to take advantage of the interest rates differentials. Thus big banks profits have been rejuvenated. It looks like inflation will still be muted as not much of the QE gets to flow to the end consumer in loans.

d) Main reason why excessive QE is bad - Do we have excessive QE, yes by a very huge sum. The WORST thing as a direct result of QE is "false confidence" in the economic system. Stock prices do  not need to correct, investors do not get penalised for making bad decisions or taking on miscalculated risks. When stock prices do not correct, property prices also do not correct. In fact, it is the very "safety option" that a lot of liquidity or wealth (not from QE) were diverted into property investment and speculation as share prices did not correct and did not present "genuine value" to the broader spectrum of investors.

e) Did investors flee USD, Euro? - To a certain extent yes, but the pendulum has swung back already (too swiftly). The best performing country bonds for the past 18 months has been Greek bonds.

f) Commodities - as these are priced in USD, by right they would have devalued. In reality they already have, its just that they have not gone up. This tells you a lot about the uncertain recovery in the global economy. If demand had been the same now as it was before the 2008 crisis, commodities may have moved up by 30% by now. The fact that it did not tells you suppliers cannot move prices up as demand was not there over the last 4 years to take up the supply. Another side shot was that there had been over-investment in commodities (oilfields, mines, etc...) and these came onto the supply chain following the 2008 crisis, which would give you the current supply-demand imbalances.

g) Property - Property is still very much in negative equity territory for many Americans and Europeans, and that is probably the only segment that actually had a correction that they had to deal with. The flip side now is that other developing economies not so affected by the 2008 financial crisis are really seeing property as a great storage of equity and wealth, so much so that domestic demand and liquidity for those respective economies are very much tied to these perceived huge jumps in property equity/wealth and/or unmitigated mortgages/debt linked to ever rising property prices - can anyone not see what is very dangerous here!!!

h) Destabilisation? - So, when your government tries to rein in property prices, IT IS A GOOD and NECESSARY THING, its not that we do not understand why it happens. Just because it is cause indirectly by QE by some other central banks does not mean we should not rein in property prices. Developers must shut up more. When you are recipients of imbalances, you enjoy the ride and enjoy the profits ... when these very imbalances causes massive dislocation in "inflated wealth perception" and excessive speculation and drives away affordability equation for most - it is a recipe for disaster if left untreated. Property developers cannot suddenly pretend to be CHIEF ECONOMIST as well, and then tell the government not to pull the brakes or do something else to address the affordability issue.

i) Currency Wars - In a classroom of theoretical economics, there would have been currency wars and massive destabilisation already. These has been very little because of issues mentioned above and the lack of options by major holders of Euro-US debt papers. Plunging the USD and Euro  by dumping half your debt papers onto the market may make your currency strengthen a lot but the end result is not one anyone wants - a weak, destabilised USA and/or EU will almost immediately plunge the rest of the world's economy into a tailspin.

So what is my conclusion - There are already pockets of bubbles being formed, in particular global property prices, and many stock indices are getting there as well. However, we do not yet have catalysts that would bring about any kind of correction in shares, property or currency. It will happen but probably not so soon. We need USA and EU to stage strong economic recoveries, thus supplanting the need for QE, thus making way for robust lending and investing again. But mind you, there WON'T BE much buying back of the QE which they released for the past 5 years - thus these would force the banks to start deploying back into the real economy .... thats when another bubble will burst, my feel is that we are 12-18 months away.


Khunie Singh said...

Hi Dali,

Mind to enlighten us a little on the part:

1.Much of the QE funds reside with the big banks which basically get cheap funds, but do not lend the same amount out. It is safer and more profitable to take advantage of the interest rates differentials. Thus big banks profits have been rejuvenated.

2. there WON'T BE much buying back of the QE which they released for the past 5 years - thus these would force the banks to start deploying back into the real economy .... thats when another bubble will burst

My understanding is the Fed is paying the banks for their excess reserves, hence they don't need to lend out to make money.

But how will the end of QE make them start lending again? This I am stuck.

Just trying to understand the bigger picture...

bruno said...

First of all why I am still stubornly hanging onto my losing S&P trades.The Dow is in an ending expanding diagonal.When it will fall off the bed,I do not know.I might have to search for a crystal ball that can tell me when it will happen.

Next Friday's NFP will tell us whether a taper or no taper will happen.If the market takes the NFP's figures negatively and the ending diagonal's support gave way,watch out.There will be hoards of wall streeters squatting outside the watering holes crying their hearts out for their mamas.

Unknown said...

The seemingly never ending QE policies have forced me to discard all the classical economics I studied at school. They simply don't work under the current environment. What does? Perhaps we should all settle for greed and more greed over all else and damn the future consequences.

OwYang said...

so many doomsayer. at the end of the day, life goes on.

as for QE, i believe the market has already factor in.

whatever crashes the market in the near future will be something unforseen, the adam smith's invisible hand. who knows? a super mega quake in califonia? or some viral infection? or a military conflict between china and japan?

Kevin Wong said...

Eventually, somebody will get his/her prediction right on the timing of the next market rout. But, what's the chances of that same persons be able to to repeat th same feat again? Its like trying to buy at market bottom & selling at market top repeatedly! So, i don't bother trying to predict pprice/market top - just sell, when its clear fundamentals & trend had clearly changed.
Be a contrarian, but ddon't ttime, outsmart market or fight mart TREND - at least thats what i learned since started investing back in 1994.

bruno said...

Our S&P shorts at 1771 with stops at 1863.

Euro shorts at 1.3555 with stops at 1.3828,200 pips from broken trendline(resistance) measured from today.

Usd/SF long at .9080.Stops at .8828 200 pips measured today at the broken trendline(support).

Further sell orders for the S&P are cancelled as I will be doing my yearly pilgrimage paying homage to the polars and the Eskimos this weekend.Trailing stops will kick in when we are comfortably in the money.

"A wonderful,cheerful and prosperous New Year and Happy Holidays to all.Cheers".

hishamh said...

I should note here that the ECB is not conducting QE in the manner of the Fed, the BoE or the BoJ. All asset purchases by the ECB are immediately sterilised, which means that new money is removed as soon as it is issued. The only net effect (so the ECB hopes) is on long term interest rates. Small wonder Europe hasn't really recovered.

@Khunie Singh

To answer your question, QE (or its cessation) doesn't effect normal loan operations at all. In the modern financial system, money is not required to issue loans - the act of lending itself creates money.

So the whole meme that money created by QE will eventually find itself into conumer and business hands, and thus trigger higher inflation, is inherently false.

The main effect is and has been on asset prices (wealth effect) and long term interest rates. Reduction and cessation of QE will therefore mainly hit financial markets, and raise borrowing costs.

Malaysia Investor said...

85% of trande transaction in the world is done in USD. How can the USD be obsolete?

As long as American is the biggest consumer in the world, there is no other currency in this world that will replace USD. When Chinese or any other country manufacturer export to USA, the business transaction is done in USD. So with so much USD receive from the exporter, they have to change it with the central bank to yuan for domestic usage.

End up, many central banks in the world has a lot of USD. AS for China case, what does the Central Bank of CHina do with the USD? They dump it back into USA by buying the US treasury bond.

SO tell me, how is USD going to be obsolete?