Analysis: Surfing central banks in a benign 'QE trap'

LONDON Wed Nov 27, 2013 1:55am EST

U.S. Federal Reserve Vice Chair Janet Yellen testifies during a Senate Banking Committee confirmation hearing on her nomination to be the next chairman of the U.S. Federal Reserve, on Capitol Hill in Washington November 14, 2013. REUTERS/Joshua Roberts

U.S. Federal Reserve Vice Chair Janet Yellen testifies during a Senate Banking Committee confirmation hearing on her nomination to be the next chairman of the U.S. Federal Reserve, on Capitol Hill in Washington November 14, 2013.

Credit: Reuters/Joshua Roberts

LONDON (Reuters) - The message is sinking in - economies of the rich world face super-easy money far into the future and central banks are now convinced it's the least of all policy evils.

Despite rumblings of dissent about the financial bubbles and iniquities associated with zero interest rates and money printing, 2013 is ending with a remarkable certainty among global investors that cheap money is around for the long haul.

And the outsize financial market reaction this year to even a suggestion the U.S. Federal Reserve would dial back money printing crystallizes the point for many. And even if the Fed does taper asset buying in 2014, liquidity from the Bank of Japan or European Central Bank could be boosted to offset it.

That's not to say money managers are all cheer leading this. Many who spoke at Reuters Investment Outlook summit last week doubted its long-term efficacy and feared its social and political fallout even as waves of cheap cash continue to push stock markets to new records.

If financial asset owners benefit more from 'quantitative easing' than the jobless or low wage earners, they insist, then monetary pumping merely exaggerates already disturbing wealth and earnings inequality in the United States, Britain and beyond - injects unforseen and incalculable political tension.

Yet despite these misgivings, most assume zero interest rates, QE and extraordinary credit easing are the only likely horizon if soundings from the halls of monetary power in Washington, Tokyo, Frankfurt were taken seriously.

"We are all long on central banks as an industry," said Pascal Blanque, chief investment officer at Amundi, which has more than $1 trillion in assets under management. "Fears about the normalization by central banks are way overdone."

"We are seeing a change of DNA of central banks. What we think non-conventional will become part of theory. And, as often in economic matters, theory comes after practice."

The zeitgeist amongst fund chiefs at last week's summit was framed, somewhat ironically, by a speech delivered earlier this month by someone considered a relative skeptic on QE compared to the incoming Federal Reserve chair Janet Yellen.

Former U.S. Treasury chief Larry Summers, once considered a candidate for the top Fed post, spoke about the prospect of 'secular stagnation' in the U.S. economy for years to come - one where the 'natural rate' of interest commensurate with full employment could be minus two or three percent.

With economists actively speculating about both the Fed and European Central Bank introducing negative nominal interest rates - or charges in effect - on deposits left by their commercial banks, then the musings are far from outlandish.

Summers' point was this growth and interest rate environment could persist for a long time and resultant asset bubbles may be an inevitable and even acceptable by-product.

"Somehow, even a 'great bubble' wasn't enough to create any excess in aggregate demand," he said, referring to the absence of inflation, wage, labor or capacity pressures even as one of the biggest credit booms in history crested in 2007.


And so if a 'secular stagnation' of sub-par growth and rock-bottom interest rates - the 'new normal' as PIMCO posited back in 2009 - is long road ahead, then liquidity-fueled preferences for corporate debt and equity as well as real estate will likely persist. That's the consensus bet at least.

For some, such as Carmignac Gestion's Didier Saint-Georges, this may leave us all in a "QE trap" - paying back over many more years the price of preventing economic catastrophe five years ago.

The artificial lowering of interest rates via QE clearly prevented a deeper economic bust in 2008/2009, he reckons. But the net result of depressed rates has been to slow and elongate any recovery as each pop in economic activity leads to minor but unsustainable interest rate rebounds that choke the upturn.

"It is a QE trap. It means the recovery will be slower, but does it have to end in tears? Not necessarily," he said, adding persistence and fine tuning by central banks can manage the process over the long term.

Marino Valensise, CIO at the $60 billion Baring Asset Management, echoes this: "The issue is whether the authorities will now ever be able to just pull the plug on QE."

If they can't, it will rankle.

"You could be locked in QE for longer if we see significant slippage on the inflation front and that has the potential to exaggerate some of the distortions that have occurred," said Philip Saunders at Investec Asset Management.

"I personally think that QE is counterproductive. Its social impact is indefensible. The price for supposedly creating a few more jobs is that basically you make the rich a lot richer through asset price inflation."

Saunders reckons some wage inflation has to be allowed to come through after "five years with the clamps on" and this may help offset some of QE distortions.

But reversing QE itself may simply not be an option.

"They have no choice," said Amundi's Blanque. "There are far more risks attached to 'normalization'."

(Editing by Ron Askew)

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Comments (11)
bobz wrote:
Right after Bernanke leaves their will be a bubble popping.

Nov 27, 2013 6:43am EST  --  Report as abuse
nose2066 wrote:
So when does the game end? When voters realize that neither political party is doing them any good?

Nov 27, 2013 9:21am EST  --  Report as abuse
lottopol wrote:
“..Most investors now believe three things about the Federal Reserve, money and interest rates. They think that the Federal Reserve is artificially depressing rates below what would be a “normal” level. They believe that in the process of doing so the Federal Reserve has enormously increased the supply of money and they believe that the USA is on a fiat money system.

All three of those beliefs are incorrect. One benchmark rate that the Federal Reserve has absolute control of is the rate paid on reserves deposited at the Federal Reserve. That rate is now 25 basis points, after being zero since the inception of the Federal Reserve in 1913 until recently. If the Federal Reserve had left that rate at zero t-bill rates would now be even lower than they are now. The shortest t-bills rates would now be probably negative.

Paying interest on reserves combined with the subsidy to the banks of providing free unlimited deposit insurance on non-interest bearing demand deposits is keeping t-bill rates positive. Absent those policies the rate on t-bills would be actually negative. The Chinese and others all over the world are willing to pay anything for the safety of depositing funds in the USA. Already, Bank of New York Mellon Corp. has imposed a 0.13% charge on large deposits.
An investor who believes that interest rates are headed up may respond that the rate paid on reserves is a special case and that the vast increase in the money supply resulting from the quantitative easing must result in higher rates when the Federal Reserve reverses its course. The problem with that view is that the true effective money supply is still far below its 2007 level.
Money is what can be used to buy things. Historically money has first been specie (gold and silver coins), then fiat money which is paper currency and checking accounts (M1) and more recently credit money. The credit money supply is what in aggregate can be bought on credit. Two hundred years ago your ability to take your friends out to dinner depended on whether or not you had enough coins (specie) in your pocket. One hundred years ago it depended on the quantity of currency in your pocket and possibly the balance in your checking account if the restaurant would take checks.

Today it is mostly your credit card that allows you to spend. We no longer have a fiat money system. Today we have a credit money system. Just because there is still some fiat money does not negate the fact that we are on a credit money system. When we were on a basically fiat money system there was still a small amount of specie in circulation. Even today a five cent piece contains about 5 cents worth of metal, but no one would claim we are still on a specie money system.

Fiat money is easy to measure; M1 was $1.376 trillion in 2007 and was $2.535 trillion in May 2013. The effective money supply is the sum of fiat money and credit money. Credit money cannot be precisely measured. However, When the person in California whose occupation was strawberry picker and who had made $14,000 in his best year was able to get a mortgage of $740,000 with no money down and private equity could buy a company like Clear Channel in a $20 billion leveraged buyout, also with essentially no money down, the credit money supply was clearly much higher than today. A reasonable ballpark estimate of the credit money supply is that it was $70 trillion in 2007 compared to $50 trillion today.
The effective money supply is the sum of the traditional fiat money aggregates plus the credit money supply. Thus, despite the clams of Ron Paul and Rick Perry to the contrary, the effective or true money supply has fallen drastically over the last few years…

Nov 27, 2013 9:34am EST  --  Report as abuse
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