THE UNINTENDED CONSEQUENCES OF QE2
It looks like the Fed is already beginning to worry about the unintended consequences of QE2. In a speech earlier this week Richard Fisher discussed an important consequence of QE. He said:
“In my darkest moments, I have begun to wonder if the monetary accommodation we have already engineered might even be working in the wrong places.”
It certainly is working in the wrong places. While the Fed creates paper profits in stocks and bonds QE appears to also be influencing the price of commodities. Commodity prices have surged in recent weeks as the Fed has driven the dollar lower. What’s so pernicious here is the margin compression that Gaius discussed the other day. This is crucial because the margin recovery has been the single most important component of the equity market recovery.
What’s so interesting here is that Ben Bernanke might actually be creating a double headwind for the economy in the coming quarters. Not only is he reducing margins for many corporations, but because quantitative easing is inherently deflationary (because it replaces interest bearing assets with non-interest bearing assets) it is not helping aggregate demand. From the perspective of a corporation this means stagnant revenues and higher input costs. That will only increase the reluctance to hire.
Of course, the Fed thinks they can prop up particular markets and generate a “wealth effect” that is unsupported by the underlying fundamentals. Interestingly, in the long-run, Mr. Bernanke might be creating more damage than he even understands. But at least someone at the Fed is beginning to wonder if this strategy is viable.
I don’t know the exact rotational schedule, but aren’t there a decent amount of hawks coming on board as FOMC voting members next year?
If so, it’s going to be interesting to see how this discussion plays out at the Fed over the coming quarters should it become apparent that things are clearly decelerating / turning to outright recession.
Looks like we’re on track to having had two back-to-back Fed Chairmen that were hell bent on re-inventing governments role in free market capitalism.
It’s funny how everyone in the media keeps talking about all of the benefits of QE and you never hear about all the downside. You’d think the Fed had a silver bullet for economic growth if you just watched CNBC.
Are you ready for it again? Earnings will all be awesome after the close and the market will rally huge, open higher tomorrow, and close higher tomorrow.
Rinse, wash repeat.
Yeah, $4 gasoline is going to do wonders for the economy. Good thinking, Ben.
TPC,
In “DOES QUANTITATIVE EASING DRIVE ASSET PRICES HIGHER?” you seem to argue that QE does not drive asset prices higher and certainly doesn’t help the real economy.
Now you seem to be suggesting QE is impacting certain asset prices:
Can you reconcile the two positions? The questions is not meant to be combative, just trying to get this QE stuff straight.
My argument is that there is no fundamental reason why QE should have a substantive impact on asset prices. Obviously, There appears to be a psychological impact at least. I’ve said the Fed is talking the market up. The media certainly isn’t hurting either because they have endlessly described QE as a market positive without pointing out any of the potential negatives.
I think QE is being widely misunderstood which is why I am betting against the market now. Higher prices doesn’t mean its right. But it is reality for now. My guess is prices will adjust lower as the fundamentals fail to meet the Fed’s cheap talk. For now, I would argue that the Fed is having a more negative impact than people are pricing in. The irrationality makes me look wrong in the short-term, but the verdict is out and probably won’t come in for several quarters. If we see a real positive change in economic growth and a vast improvement in loan demand I will have some explaining to do….
Got it. Thanks. There is not an intrinsic reason QE drives asset prices higher however the market is misinterpreting its effects. The psychological effects are on full display in the AAII survey today….bullish sentiment up to nearly 50% and 8-week rolling average at level last seen in Mar ’07.
BTW- I agree with you. The fundamentals are not good and the market is no longer cheap.
TPC: QE reduces borrowing costs. As a result, it directly impacts DCF calculations to the positive.
Yes, I’ve discussed this. Unfortunately, DCF models don’t create economic growth. Mr. Bernanke appears to think otherwise, however.
In a balance sheet recession I have argued that moving the interest rate has only a marginal impact on the real economy. It might make equities appear more attractive in the near-term (especially in computer models), but it does little to nothing to justify the risk premium in equities in the long-term as QE really has a muted effect on the real economy. All we’ve done is reduce borrowing costs marginally. Unfortunately, consumers aren’t interested in taking on more debt. Corporations can take on more debt, but that won’t drive aggregate demand. More likely, they’ll chew eachother up and/or sit on the cash.
Does anyone still use DCF these days? I thought it was as simple as risk-on / risk-off.
I agree, lower rates do affect a DCF valuation but with rates already historically low the affect should not be as dramatic as they have been at other times.
The lack of low rate is not the problem nor will lower rates be the solution.
Con QE: QE reduces aggregate income in the economy by not only removing income producing assets (swapping with cash), but also by pinning down the yields on all other assets. Savers get less income on their capital.
Pro QE: Businesses get to reduce borrowing costs dramatically. Investors are forced to seek more risk in order to get real return on capital.
One might think of QE as like a whip against a mule’s backside. Will it work?
Guys the post about $4 gas brought up memories of an incredible article written by Matt Taibbi… fairly long but amazingly written.
http://www.rollingstone.com/politics/news/12697/64796?RS_show_page=0
Would love to hear what you think about this… might be old news for some on you though
take care
Populist garbage written by a sensationalist moron.
TPC, I agree with your fundamental analyses. However, remember that this is America. We are highly innovative, persevering spirits. We do not readily give up. And we tend to seek order rather than chaos. We will rise again.
The Fed (through jawboning) is merely attempting to erect a temporary suspension bridge to keep us aloft until the fundamentals actually match market levels. So far, Bernanke has been doing an excellent job of snake charming the masses. He is no fool.
I would be very carefull in deciding to bet against this Fed.
The problem is, through its manipulative policies (ZIRP and QE)the Fed is actually preventing, or at best discouraging the innovation we so desperately need. Instead its policies favor the mis-allocation of capital. The Fed is attempting to prop up the housing market and doomed financial institutions neither of which boost long term innovation and productivity.
More aggregate demand stuff…so glad I am going on a mini vacation. I think output gaps depend heavily on where you are measuring. I wrote this last night:
“When the automobile caused a serious “output gap” in the horse cart manufacturing industry how come they did not target that gap with cheaper money? Think of all the oil we could have avoided using all this time!
-Related: What if the consumption and output level of right now is actually steady state equilibrium? Makes all being done look pretty stupid, yes?
-Related 2: When you get in your car do you immediately gun it to 100 mph to re-capture your highest speed ever output? Why not?”
The Reformed broker has an item up today that says the FED should RAISE rates to 1% like right now in a shocker move and this would get business off the fence on spending plans. I would love TPC’s take on that.
There is something I can’t understand about QE. From what I understand it is supposed to create inflation by driving up the prices of commodities and to increase trade by driving down the value of the dollar. But, my problem is that it is not facing the real problem of private debt and the tax structure. It seems to me it will simply cause push inflation and cut aggregate demand. Let’s face it, driving down the dollar cuts real wages in the US and thus will cut demand. It also raises prices which will cause inflation and people to buy less {they won’t be able to afford things or to go into debt for more}. Please tell me how that can be beneficial.
Also, Albatross, I know I shouldn’t saw this, but think of QE more like a limp XXXX, everybody is all excited, but there ain’t nothing going to happen. Sorry.
Yes what GLH said…
How about the negative impact on older consumers who partially rely on their interest income?
Nice kick in the groin for them isn’t? We effectively reduce the burden on the people that made bad decisions while hurting those that saved. It would be hilarious if it wasn’t so damn sad.
Have to learn to invest rather than save.
Whether this class of consumer needs to learn to invest vs save is not the issue of this post. The concern is the unintended concequences of artificially lowering rates through QE. And I believe one of the economic concequences of QE in an economy where you have more elderly consumers all the time is a reduction in this group’s consumption because of lowered interest income. Especially as their three and four year CD’s mature.
From Deutsche Bank:
“We estimate that every one percentage point decline in the real trade-weighted dollar translates into a $6 per barrel increase in oil prices. Every $6 dollar increase in oil prices is worth three cents more on retail gasoline prices. In turn, a three cent increase in retail gasoline prices is worth $3 billion in higher household energy consumption. Consequently, we can draw the conclusion that all else being equal, a one percentage point decline in the real-trade weighted dollar is equivalent to a $3 billion energy-related tax on household consumption.”
regional head fed hoenig worried about QE2 making an irrational short term bull trap stock bubble.
ya think?