QE2 was a disaster and so would be QE3. Its a balance sheet recession.
By Shan Saeed
The unwind of the carry trade has been in full swing for a couple of days now. It’s probably been accompanied by repatriation of capital by Japanese investment trusts and the like – time will tell. Without the aid of intervention – it’s likely that the peak of this flow has passed. Still, the withdrawal of the world’s best savers from the global capital markets can be expected to put upward pressure on interest rates from here on in. There would be lot of headwinds in the global financial markets as Decision makers try to navigate through turbulent times strategically.
Next phase of the crisis, as it will be played out in capital markets at least, will unfold over a couple of weeks as the impact on individual actors become clearer. Given the enormity of the events, it is unlikely that we will see a return to the optimism of a week ago – bounces in risk assets will be sold into. Stocks and equity market would take correction of 10-15% globally. Commodities will continue to upsurge as US dollar would stay weak.
The response from global governments, if they stick to the same script, will be to once again turn to the stimulus levers. Given that these have been overused of recent times, fiscal policy options are now somewhat constrained. As a result, it’s likely that ‘unconventional monetary policy’ will remain a feature of the landscape. In the US, the liklihood of QE3 being pre-announced ahead of the closure of QE2 has just risen dramatically. Inflation is aroung 5-7% in US and living standards have gone down by 20% courtesy Quantitative Easing. Japanese government will print money as well. QE is going global and getting global recognition.
So while we can argue cause and effect, fears of further price rises in real goods may be amplified by the crisis in Japan. It’s a balance sheet recession. Whenever you have a giant bubble collapse, and the whole economy goes under, then you enter into unusual territory. If millions of homeowners are underwater on their
mortgage notes, are they going to take out loans? No, they want to pay
down their loans if they can, and that is what is happening. Deleveraging would cost $5-6 trillion to the American consumers. This would create sub-par GDP growth going forward. BUT,since most of the money supply comes from credit money i.e. money
borrowed at the bank, then the money supply COLLAPSES when people don’t borrow.
The QE maneuvers are an asset SWAP. The FED trades out cash for bonds
held at the big banks. It is equivalent to the average person taking
money out of his savings account and transfering it to his checking
account. The bank is no longer earning interest, and cash is available
to lend. The FED also buys bonds from the Treasury, so the treasury can deficit
spend up to their authorization level.
The flaw is that banks are not revenue limited to issue loans. If you
have a good credit rating, the bank will lend to you despite what they
have in reserves. The bank can borrow money anytime to back up a new
loan. So, the quantitative easing forces some banks to speculate in
order to keep their profits up. Think of it like the banker in the
game monopoly getting to play AND be the banker. But again, people are
not taking out loans, and the banks are sitting on piles of cash. You
cannot push on a string.
What the government should do and they aren’t, is direct spending into
main street. Simply issue cash to build bridges, infrastructure, and
so on. That will put people to work, thus improving wealth. It will
also put money in peoples hands so they can pay down their upside down
loan debts to the bankers.
The bottom line is the money needs to be issued vertically when you
have a balance sheet recession. How it is spent is very important, and
there are no good laws or sensibility issuing forth from Washington. I
blame it on predatory financial capitalism that has captured
Washington. Its like a revolving door of Goldman Sachs type people at
the levers of power, and they have pulled the wool over idiot lawyers
eyes in Washington.
A sovereign people should not have to borrow their own credit. I
think the banking class as important, but they really
aren’t. All a banker should do is match up creditors with debtors.
They should intermediate between credit and debt, and earn a fee for
their services. That’s it. As soon as US politicians and public
figure out that the money power rightly belongs under legal control,
then it can move on to a bright future. A federal political system is
ideal for controlling the money power through proper poltical
representation. In case of US, the money power is held in private hands,
and has usurped political power. Big difference.
During the great depression, FDR borrowed money to build things like
the Hoover dam. This money put people to work, and left behind
tangible wealth. The country was better off for putting people to work
and creating real wealth. At first the banks wouldn’t make any loans,
until they were threatened with the Thomas ammendment, which would
have allowed debt free greenbacks thus bypassing the banking system.
When WW2 came around the bankers opened their wallets to the max. They
agreed to 3/8 of 1% (memory, but it is close). In other words, the
bankers issued plenty of credit at low interest rates, when they knew
our tanks and planes would be blown up, but the debt would remain.
Imagine how much can get done in a balance sheet recession if US government spent
money to build infrastructure, low cost housing, strucural reforms and fiscal discipline, etc. There is plenty that needs to be done. Instead, since US does not have good laws, and doesn’t understand money, the deficit spend so people can sit on their rears in unemployment. Pumped money into the banking system, usually to create / gather dust, or be speculatively spent to create bubble in the financial markets.
Disclaimer: This is just a research piece and not an investment advice. Investors are encouraged to execute their own due diligence before making any stategic investment or implementation.