KOO: QE HAS FAILED IN THE U.K. & THE U.S.A. IS ENTERING A SLOWDOWN
The latest from Richard Koo has two really interesting points. The first is the fact that QE has failed to boost the UK economy (shocking since its transmission mechanism is non-existent!) and the second is his opinion that the USA is entering a slowdown (not sure what that means precisely since we’ve basically been in one long stall for years). On UK QE he says:
“Bank of England governor Mervyn King, a supporter of the Cameron government’s fiscal consolidation drive, launched a bold program of quantitative easing in mid-2011 that can be called a British version of the Fed’s QE2. But the easing failed to prevent the recession.
The program’s failure was only to be expected. With both the private and public sectors borrowing less during a balance sheet recession, the money multiplier turns negative at the margin, causing any liquidity supplied by the central bank to stay within the banking system and preventing growth in the money supply.
The UK money supply has increased only marginally even though the BOE has expanded the nation’s monetary base by 45% in just half a year under this program (Figure 2).
What I find difficult to understand is why Mr King would support fiscal austerity at a time when both businesses and households are paying down debt and increasing savings despite near-zero interest rates—in other words, when government borrowing and spending is the only way to expand the money supply.”
To be expected really. QE has been the world’s greatest non-event as I described several years ago. With the credit system clogged up there is just no way for QE to impact the economy.
On the USA slowdown he says:
“Recent data suggest the US economy is also decelerating. In my view, this is more a case of a basically weak economy returning to normal following a temporary boost from unseasonably warm winter weather.
The official US unemployment rate dropped to 8.1% in April. The main cause of the decline was the record low labor force participation rate, indicating that large numbers of people have given up looking for work and dropped out of the labor force. That is hardly good news.
Fed Chairman Ben Bernanke touched on the subject of the labor force participation rate at his press conference after the FOMC meeting on 25 April. Mr Bernanke indicated that an aging population means the participation rate is naturally trending lower but said the sharp recent decline was largely a cyclical development attributable to economic weakness.
He also said the unemployment rate no longer necessarily coincided with economic developments, noting a stronger economy could prompt people who had abandoned their job searches to return to the labor force, pushing the unemployment rate higher.”
However, I think this was partly an attempt to justify the fact that the actual unemployment rate has been far lower than Fed forecasts suggested.”
I still don’t see it. We’ve basically been in one long stall phase for years now. The budget deficit in the USA has helped bolster growth enormously. But perhaps more importantly, we’re beginning to see credit come back. This is where the USA and UK really diverge. The UK is still experiencing very weak borrowing trends while balance sheets in the USA have sprung back to life much more quickly. I’ve referred to the USA as “Japan on fast forward”. Koo has expressed his displeasure with this opinion, but I think the evidence is clearly pointing to improving borrowing trends and the balance sheet recession in the USA ending sooner rather than later. Of course, that’s all assuming the government doesn’t torpedo this tepid recovery with austerity in the coming 12 months…..
Source: Nomura Securities
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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Cullen,
I’m curious as to what debt sectors you see coming back that make you relatively optimistic? Aggregate debt is still declining as the mortgage deleveraging process slowly continues. Non-corporate debt is declining. The only types of debt that are increasing are corporate debt, student loans (so the next generation begins adulthood already overleveraged) and credit cards (unsustainable without a proportionate rise in incomes). It still seems to me that we have a long way to go in our deleveraging process, especially if any of the fiscal cliff comes to pass.
Hey Erik. IMO, it was a household debt crisis. So to me, the fact that household debt is turning around and nearly positive is big. What metrics are you looking at specifically?
http://research.stlouisfed.org/fred2/graph/fredgraph.png?&id=CMDEBT&scale=Left&range=5yrs&cosd=2006-10-01&coed=2011-10-01&line_color=%230000ff&link_values=false&line_style=Solid&mark_type=NONE&mw=4&lw=1&ost=-99999&oet=99999&mma=0&fml=a&fq=Quarterly%2C+End+of+Period&fam=avg&fgst=lin&transformation=pc1&vintage_date=2012-05-08&revision_date=2012-05-08
CR’s chart over a longer time period: looks like prior recessions only ended when household credit growth was >5% per year. And higher than that in more recent years, reflecting the diminishing GDP returns to increasing credit extension. Merely low-positive credit growth does not seem to be ‘big’ in terms of what recovery is needed now.
How long will it take to get back to that level? Years and years. So I take CR’s ‘optimism’ (per Erik’s term) to be more like ‘not extremely negative’.
http://research.stlouisfed.org/fred2/graph/fredgraph.png?&id=CMDEBT&scale=Left&range=50yrs&cosd=1962-04-01&coed=2012-04-01&line_color=%230000ff&link_values=false&line_style=Solid&mark_type=NONE&mw=4&lw=1&ost=-99999&oet=99999&mma=0&fml=a&fq=Quarterly%2C+End+of+Period&fam=avg&fgst=lin&transformation=pc1&vintage_date=2012-05-08&revision_date=2012-05-08
http://research.stlouisfed.org/fred2/graph/?id=HSTCMDODNS
I was looking at the same, and also agree the household sector is the most important. What I see within that sector is a slow but steady mortgage deleveraging offset by increasing student loan and credit card debt. I think that the mortgage deleveraging will accelerate now that some of the bottlenecks in the legal system have been partially cleared. I don’t view the student loan growth as a particularly positive economic development for 3 reasons 1)It’s coming from the Fed govt, so it doesnt show that private credit conditions have improved 2) A generation of kids will be highly leveraged upon beginning adulthood and 3) Much of that will feed into increasing already too high tuition costs.
The credit card debt increase would be a sign of healthy consumption in times of increasing incomes, but I view it as a temporary drop in the personal savings rate that people won’t be able to sustain without income growth to match.
Yep, I asked about this growing student loan debt in a Q&A a few weeks ago. I don’t see how an increased tuition and loan burden (paired with high youth unemployment) won’t act as an economic drag on the younger generation, whether through decreased consumer spending, household formation (i.e. housing), and/or potential future earnings. The baby boomers are going to need the echo boomers to take the economic baton and run with it, but I’m worried we’re making that more difficult.
To be clear, in this article QE refers to government bonds and (more or less gov backed) MBS only.
It would be interesting to hear Koo’s view of QE involving private assets (stocks, REITS, IG) and the Japan experience (private excludes those MBS which are already on-boarded to the US gov balance sheet). I’m not sure Japan did private QE in enough quantity to make any difference, but I don’t remember Koo discussing it in his book.
Koo has discussed the purchase of equities before and how this can distort fundamentals from prices. I think he did a DCF based analysis there or something. A search of the site for DCF would probably pull up a few of my old QE articles….
Cheers, found the link: http://pragcap.com/richard-koo-ponzi-finance-failed
I didn’t find his gut-feel very convincing for the following reasons:
- the CBs can target price if they want to (same comment as MMT/MMR on gov bond QE), and we know it could work, although it would be dangerous/unprecedented
- an asset swap of safe for a risky asset does have a BS portfolio effect (think banking rules on risk-weighted capital ratios)
- perhaps Koo was also saying that the TARP injection of preferreds to banks was ineffective, but we know it was effective (at least for the “stress tests”, and in any case, if the bank failed, it would fall to the gov to cleanup the mess)
- one could think of fiscal policy as a BS rebalancing asset swap … privates delever, public relever; not much different except it is held on the CB’s BS and isa contingent liability for the gov in the end
QE in the UK was a far smaller percentage of GDP than in the US.
No, I think Richard Koo is spot on. Both with the “”money multipier”" and his call on the US recession. Yes, credit growth is picking up but does the general public benefit ? I doubt it.
Koo is wrong on the topic of the “”money multiplier”". Because what we had in the last (at least 30 years) was a “”credit multiplier”". The growth of money was up to mid 2008 much smaller.