MORE EVIDENCE THAT QE DOESN’T WORK

I’ve made some fairly good calls over the last few years, but I don’t attribute a single one of them to any sort of prescience, brilliance or great knowledge.  Most of these cases are simply due to the fact that I’ve studied a great deal of market history.

When I said the housing bubble was the greatest risk to the equity markets in 2006 it was largely due to the fact that the price action in U.S. real estate was almost perfectly identical to residential real estate in Japan in the 80’s.  When I said the banks were likely a buy on March 10th 2009 it was almost entirely because I had studied the history of past asset class declines (Nasdaq had declined 93% from its peak in 2001 – the same exact percentage decline at the bank sector’s low).  When I said the bailouts were likely to have a muted impact on the Main Street recovery it was almost entirely due to the fact that the Japanese had implemented a similar plan in the 90’s with poor results.  This isn’t brilliance.  It’s just research.  Anyone can do it.  But here we all are pondering the impacts of quantitative easing when we have historical precedent and despite poor results most investors and policymakers seem to be saying “this time is different”.

Of course, the whole theory behind QE revolves around the idea that the Central Bank can reduce long-term interest rates.  If they can reduce rates they can make other assets more attractive, they can create a refinancing effect, they can entice borrowing/lending and they can alleviate the pressure on debtors.  All of this will theoretically help boost aggregate demand and result in sustained recovery.  There is only one problem with all of this.  There is no historical evidence that QE actually works to lower interest rates.  I’ve already highlighted the two most famous cases – the USA and Japan where interest rates rose throughout the programs, borrowing remained weak and the economies remained weak.

One instance that is less well documented, however, is the case of quantitative easing in the UK.  The following chart shows the duration of the program and the interest rate effect:

The conclusion is obvious.  Interest rates do not decline during a program of quantitative easing.  In fact, in all three cases I’ve highlighted interest rates rose throughout the program.  This is extremely important to understand because without the intended interest rate decline there is simply no argument in favor of this policy.  There is no refinancing effect, there is no reduced rates to borrow at, there is no fundamental change in the economy.  This is why, after all three instances, the economies remain(ed) very weak.  QE is merely an asset swap.  It doesn’t alter net private sector financial assets.  It does not reduce rates.  It does not create jobs.  It does not boost aggregate demand.

Thus far, the only thing QE appears to do is drive asset prices higher without being supported by any underlying fundamental change.  This is largely due to the psychological impact of QE and the falsehood that QE = “money printing”.  Thus far, this psychological impact of QE has backfired on the Fed as input costs have surged and the Fed has inadvertently begun to reduce corporate margins.  If the goal here is to keep “asset prices higher than they otherwise would be” then the Fed appears to be winning their battle.  Unfortunately, there is no evidence showing that there is a fundamental reason why QE would justify such a move.  In fact, the market collapses following the end of all three major historical QE programs appears to prove that this is bordering on ponzi Central Banking and nothing more.

Mr. Bernanke appears to be ignoring the simple historical facts.  And those who ignore history are destined to repeat it.