QE is effectively creating money, which is then used to purchase financial assets in the hope that the person selling it will use the proceeds for something that is economically stimulative. It also reduces borrowing costs along the way.
Most central banks buy government bonds. As a result of this buying, the returns on these bonds are reduced and supposedly less attractive to the investors that previously would have bought them (or did buy them and then sold them to the central bank).
The issue is that an investor that previously would have bought a government bond, doesn't suddenly decide to spend that money in the general economy because government bond returns went down. They instead put it into other financial assets, like corporate bonds, the stock market, or perhaps real estate, thus driving a bubble in these asset classes.
In places like Japan, the central bank buys nearly all bonds issued by the government (effectively financing the government deficit). This distorts markets tremendously. Japan is the most indebted developed government in the world with close to zero GDP growth for 20 years and yet you need to pay them to loan them money for 10 years (i.e. negative return on their bonds).
As an investor, you currently have to pay the governments of most Western European countries to loan them money. In Switzerland for example, if you loan them $100 today, you'll get back $98 in 2 years and no interest. Even Spain and Italy which are in terrible shape fiscally, have a negative return on their 2 year bonds [1].
We now have extremely distorted markets. Heavily indebted governments around the world are borrowing money for free, enabled by their "politically independent" central banks. Some central banks are purchasing equities outright (Bank of Japan announced last month they would double their purchasing of equity ETFs).
There's also a great deal of research indicating that such QE policies increase wealth inequality, by driving up the price of financial assets (which are owned by the rich) and increasing the cost of living for everyone else that needs access to these assets (rent etc.) [2]
To most laymen, the idea that creating money and buying financial assets will somehow stimulate spending and inflation is clearly flawed. Central banks by design however, have few other options.
> The issue is that an investor that previously would have bought a government bond, doesn't suddenly decide to spend that money in the general economy because government bond returns went down. They instead put it into other financial assets, like corporate bonds, the stock market, or perhaps real estate, thus driving a bubble in these asset classes.
What's even scarier is that the ECB has started buying corporate bonds (https://www.ft.com/content/e551c28e-457a-3b62-a8b0-a8e8ca4e5...) directly, which I personally find crazy. I won't even comment on the financial situation in Japan, which I find even more crazy, and where I think that the economic system is partly nationalized "de facto". Under these circumstances the FED policy seems the more rational, which would have been crazy to think that would happen just after 2008.
Even crazier, the criteria for which bonds to buy heavily favor German corporations. At this point the Euro system has become a system to shovel wealth from the periphery to the center at gunpoint.
IMO next step of the ECB will be equity buying, again Central European equity most likely. After that, only People QE is left (which they should have done first), but I don't think their ideology will allow that.
>…Heavily indebted governments around the world are borrowing money for free…
I don't disagree with any of what you say, but this part in particular makes me think that at the end of the day, governments around the world (esp "developed") ones are having a hard time allocating their ability to acquire resources (with their fiat currency effective "infinite money") in a way that will appease their respective populous.
Is this a political failure of us all to hold our governments accountable? Are we witnessing the inability of fiat currency systems to effectively act as a way to distribute physical resources beyond this current threshold to those with a "need" that can't quite be satisfied with current availability of such resources on global markets?
What seems to be the case is that when notional value out paces market value (or price what people are willing or able to buy at, if any buyers at all at any given price points [beyond those who are able to borrow for free at large $ levels) in any given asset classes, there isn't really any good market incentive to correct such (but plenty of bad ones like defaults on contracts). I really don't see things changing soon without drastic changes to how we all consider resource allocation in general.
You raise some interesting points. I would draw a distinction though between fiat currency and the present environment. We've had fiat currency for a long time, but the current level of monetary easing is a recent affair.
I do wonder what the end game is. In the absence of meaningful levels of inflation, central banks are confident in maintaining and increasing QE in the belief that if it's not working, it must be because it's not enough.
The problem is that at some point (perhaps already), governments and corporates wont be able to tolerate higher borrowing costs.
US government debt is double what it was in 2007 (~USD 18 trillion vs 9) and yet the annual interest cost is around the same. The Japanese government would need to spend every dollar of income and corporate tax revenue just to pay the interest if the interest rate on their debt rose to just 4.5%.
QE generally has the bonus effect (and some would say it's the primary motivation) of devaluing your currency. The problem though is that this only works if noone else is doing it. From Kyle Bass:
I had a fascinating out of body experience meeting with one of the world's top central bankers in a private meeting about three years ago. And he said, "You know Kyle, quantitative easing only works when you're the only country doing it."
the problem with the 'wealth' effect, or equality effect, is that the person selling the asset is likely retired or close and won't spend it and the increase in asset prices take an equal amount from the people who need to buy for their retirements but can't because central banks own them all. So those people of working age who might have spent more are poorer and will spend less too.
The question is why central bankers can't figure that out instead of doubling down on what is basically a transfer of wealth from working age to old.
Based on many papers, articles, and interviews by many central bankers I have come to the conclusion that most of them aren't very smart to say the least.
They think of a country as a household, rather than a complex system. Economic orthodoxy is also very irrational atm.
What expertise do you have that makes your judgement of central bankers meaningful? Do you have any understanding of macroeconomics, forecasting, monetary policy?
I think there's a logic to QE in scenarios like the credit crunch, since suddenly banks need cash and there's a bunch of illiquid assets on everyone's balance sheets. But I do agree that owners of treasury bonds aren't really going out and spending their proceeds at Wal-Mart for a while.
TARP was a very specific program that had very specific goals. It was strictly intended to prevent the collapse of the banking sector, not to inflate the economy more generally. It may have done that as a side effect, but that was not its primary purpose.
All the same people who fucked stuff up are still in charge and still have all their money. How do you figure it worked, even one iota, except for them?
We have plenty of jails and very few bankers in them, despite widespread fraud. Again, not sure how this is a success.
We need banks, but we don't need the ones we have. Ruthlessly prune them, guaranteeing the people's deposits, and capitalize new ones with stricter rules. Of course, now it's too late. We've printed trillions of dollars, inflating our currency, and given it to the thieves without (meaningfully) changing the system.
Most central banks buy government bonds. As a result of this buying, the returns on these bonds are reduced and supposedly less attractive to the investors that previously would have bought them (or did buy them and then sold them to the central bank).
The issue is that an investor that previously would have bought a government bond, doesn't suddenly decide to spend that money in the general economy because government bond returns went down. They instead put it into other financial assets, like corporate bonds, the stock market, or perhaps real estate, thus driving a bubble in these asset classes.
In places like Japan, the central bank buys nearly all bonds issued by the government (effectively financing the government deficit). This distorts markets tremendously. Japan is the most indebted developed government in the world with close to zero GDP growth for 20 years and yet you need to pay them to loan them money for 10 years (i.e. negative return on their bonds).
As an investor, you currently have to pay the governments of most Western European countries to loan them money. In Switzerland for example, if you loan them $100 today, you'll get back $98 in 2 years and no interest. Even Spain and Italy which are in terrible shape fiscally, have a negative return on their 2 year bonds [1].
We now have extremely distorted markets. Heavily indebted governments around the world are borrowing money for free, enabled by their "politically independent" central banks. Some central banks are purchasing equities outright (Bank of Japan announced last month they would double their purchasing of equity ETFs).
There's also a great deal of research indicating that such QE policies increase wealth inequality, by driving up the price of financial assets (which are owned by the rich) and increasing the cost of living for everyone else that needs access to these assets (rent etc.) [2]
To most laymen, the idea that creating money and buying financial assets will somehow stimulate spending and inflation is clearly flawed. Central banks by design however, have few other options.
[1] https://twitter.com/MktOutperform/status/773577673587105792
[2] http://www.bloomberg.com/news/articles/2016-03-10/how-centra...