The End of Quantitative Easing

Sensex hits record high: Now Japan takes over the easy money party from the US

japanVivek Kaul

Two days after the Federal Reserve of the United States brought to an end its money printing programme, the Bank of Japan decided to do exactly the opposite. In a surprise move the Japanese central bank on Friday (October 30, 2014) decided to increase the amount of money it has been printing to get the Japanese economy up and running again.
The Bank of Japan will now print 80 trillion yen (or around $727 billion) per year. The central bank has been printing money since April 2013 and was earlier targeting around 60-70 trillion per year. It pumped this money into the financial market by buying Japanese bonds.
In fact, the Bank of Japan entered the money printing party rather late. The money printing efforts of the Japanese central bank in the aftermath of the financial crisis were rather subdued and it had expanded its balance sheet (by printing yen and buying bonds) by only 30% up to December 2012. And then things changed.
This was after Shinzo Abe took over as the Prime Minister of the country on December 26, 2012. He promised to end Japan’s more than two decades old recession through some old-fashioned economics, which has since been termed as Abenomics.
Abenomics is nothing but money printing in the hope of creating some inflation. Abe’s plan was to get the Bank of Japan to go in for money printing and use the newly created “yen” to buy Japanese bonds.
By buying bonds, the central bank ended up pumping the printed money into the Japanese financial system. The hope was that all this extra money in the financial system would lead to lower interest rates. At lower interest rates people would borrow and spend more, and in the process the government would manage to create some inflation, as more money would chase the same amount of goods and services.
The Bank of Japan, the Japanese central bank, went with the government on this and is targeting an inflation of 2 percent. It wants to reach the goal at the earliest possible date, by printing as much money as maybe required.
And how will that help? In December 2012, Japan had an inflation rate of –0.1 percent. For 2012, on the whole, inflation was at 0 percent, which meant that prices did not rise at all. In fact, for each of the years in the period 2009–2011, prices had fallen in Japan.
When prices are flat, or are falling, or are expected to fall, consumers generally tend to postpone consumption (i.e., buying goods and services) in the hope that they will get a better deal in the future. This impacts businesses, as their earnings either remain flat or fall. This slows down economic growth.
On the other hand, if people see prices going up or expect prices to go up, they generally tend to start purchasing things. This helps businesses as well as the overall economy. So, by trying to create some inflation the idea is to get consumption going again in Japan and help it come out of a more than two decades old recession.
In fact, when it started to print money, the Bank of Japan had planned to inject $1.4 trillion into the Japanese financial system by April 2015. This was pretty big, given that the size of the Japanese economy is around $5 trillion. Now it will end up printing even more yen. The size of the balance sheet of the Bank of Japan has gone up rapidly since March 2013, a month before it actually started to print money.
Back then the size of the balance sheet of the Bank of Japan had stood at 164.8 trillion yen. Since then it has jumped to 276.2 trillion yen as of September 2014. This has happened because the Bank of Japan has printed money and pumped it into the financial system by buying bonds.
The question is why has the Bank of Japan decided to increase the quantum of money printing now. The answer lies in the fact that even with all the money printing it hasn’t managed to create the desired 2% inflation even though the inflation in Japan is at 3.4%. But how is that possible? As investment letter writer John Mauldin explains in a recent column “What you find is that inflation magically appeared in March of this year when a 3% hike in the consumption tax was introduced. When government decrees that prices will go up 3%, then voilà, like magic, you get 3% inflation. Take out the 3% tax, and inflation is running about 1%.”
Given this, the real inflation is at 1%. The Bank of Japan wants to increase it to 2% and hence, has decided to print more money than it did before.
The irony is that Bank of Japan like other central banks in the developed-world before it have, is trying more of a policy which hasn’t worked for it. James Rickards explains this dilemma beautifully in The Death of Money: “the great dilemma for the Federal Reserve and all central banks that seek to direct their economies out of the new depression [is that] … the more these institutions intervene in markets, the less they know about real economic conditions, and the greater the need to intervene.”
This move by the Bank of Japan also means that the era of “easy money” will continue. More money will now be borrowed in yen and make its way into financial markets all over the world. In fact, the Indian stock market has already started partying with the Sensex rallying by 519.5 points or 1.9% and closing at 27,865.83 points on Friday.
And this is the irony of our times. The stock markets treat bad economic news as good news because the investors know that this will lead to central banks printing more money as they try and get economic growth going again.
As Gary Dorsch, Editor, Global Money Trends newsletter, wrote in a recent column “Bad economic news is treated as Bullish news for the stock market, because it lead to expectation of more “quantitative easing.” Quantitative easing is the term economists use for central banks printing money and pumping it into the financial system by buying bonds. This is precisely what is happening in Japan.
As Dorsch further points out “And the easy money flows that are injected by central banks go right past goods and services (ie; the real economy) and are whisked into the financial markets, where it pushes up the prices of stocks and bonds. In simple terms, what matters most to the stock markets are the easy money injections from the central banks, and to a lesser extent, the profits of the companies whose stocks they are buying and selling.”
To conclude, this is not the last that we have seen of a developed-world central bank deciding to print more money to create some inflation. There is more to come.
Stay tuned.

The article originally appeared on www.FirstBiz.com on Nov 1, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

Why the US Fed will not be sucking out all the printed money any time soon

 

Vivek Kaul

The Federal Open Market Committee(FOMC) is scheduled to meet on October 28-29. This is one of the eight regularly scheduled meetings during the year. It is widely expected that the Janet Yellen led Federal Reserve will more or less bring quantitative easing to an end.
Economists like to refer to the good old money printing as “quantitative easing”. The Federal Reserve till date has printed around $4 trillion and pumped it into the financial system. It currently prints around $15 billion per month and pumps this money into the financial system by buying government bonds and mortgage backed securities.
The writer John Lanchester perhaps describes quantitative easing(QE) in the simplest possible way and what it really stands for by cutting out all the jargon in his new book How to Speak Money. As he writes “QE involves a government buying its own BONDS using money which doesn’t actually exist. It’s like borrowing money from somebody and then paying them back with a piece of paper on which you’ve written the word ‘Money’ – and then, magically, it turns out that the piece of paper with ‘Money’ [written] on it is actually real money.”
Lanchester describes QE in another way as well. He compares it to a situation where an individual while looking at his “bank balance online” also has “the additional ability to add to it just by typing numbers on [his] keyboard.” “Ordinary punters can’t do this, obviously, but governments can; then they use this newly created magic money to buy back their own debt. That’s what quantitative easing is,” writes Lanchester.
This has been done in the hope that with all the newly money created being pumped into the financial system, there would be enough money going around and interest rates would continue to remain low. At lower interest rates the hope was people would borrow and spend more, and this in turn would lead to economic growth.
This did not turn out to be the case. What happened instead was that financial institutions borrowed money at very low interest rates and invested that money in financial markets all over the world. This explains to a large extent why stock markets have rallied all over the world in the recent past.
Lanchester believes that instead of going through the QE route the Western governments should have simply handed over this money directly to the people. He makes this comment in the context of the United Kingdom. As he writes “In the UK, the government has spent magic money on QE to the tune of £ 375 billion, an amount equal to 23.8% of…GDP…If they’d just had given the money direct to the public, perhaps in the form of time-limited. UK-only spending vouchers, it would have amounted to just under £ 6,000 for every man, woman and child in the country. Can anyone doubt that the stimulus effect that would have been much bigger?”
A similar argument can be made for the American economy as well. Nevertheless, this is just a counterfactual and something that did not happen.
Now the US Federal Reserve is likely to stop printing money after its meeting over two days. Does that mean there will be trouble ahead? As Lanchester writes “Nobody quite knows what’s going to happen once QE stops. In fact, the ‘unwinding’ of the QE is on many people’s list as the possible trigger for the next global meltdown.”
Once the US Fed stops printing money, new money will stop coming into the market every month. Hence, perpetually increasing liquidity will come to an end, at least in the American context.
So, does that mean interest rates will start to go up? The answer is no. As Mohammed A. El-Erian wrote in a recent column for Bloomberg “They will reiterate their willingness to keep interest rates low, should economic conditions warrant it. In doing all this, Fed officials will again try to buy time — both for the economy to heal and for politicians to step up to their responsibilities — hoping for better times ahead.”
What this means in simple English is that the Federal Reserve will not start sucking out all the money it has printed and pumped into the financial any time soon. And this means that the era of “easy money” will continue for the time being.
The reason for this is fairly straightforward. Even though the American economy is doing much better than it was in the past, the recovery at best has been fragile. The US economy grew by 4.6% during the period between July and September 2014, after having contracted by 2.1% during April to June, earlier this year.
The rate of unemployment in the US has been coming down for quite a while now. In September 2014, it stood at 5.9% against 6.1% in August. This rate of unemployment is around the average rate of unemployment of 5.83% between 1948 and 2014. It is also below the 6.5% rate of unemployment that the Federal Reserve is comfortable with.
Nevertheless, even with these reasons, the Federal Reserve is unlikely to start sucking out money and raising interest rates any time soon. This is because the US has become what Lanchester calls a “two-speed economy”. Lanchester defines this as “an economy in which different sectors are performing differently at the same time”. In the American context, it is a matter of Texas and the rest of the country.
The state of Texas has been creating more jobs than any other state in the United States. As Sam Rhines an economist at Chilton Capital Management points out in a recent article in The National Interest “From its peak in January 2008 through today, the United States has created only 750,000 jobs. Texas created over a million jobs during that same period—meaning that the rest of the country (RotC) is still short 300,000 jobs. During the recovery, job creation has been all Texas or—at the very least—disproportionately Texas.”
This has meant that the contribution that Texas has been making to the US economy has increased over the last few years, from 7.7% in 2006, it now stands at 9%. So, if one takes Texas out of the equation, the United States still hasn’t recovered all the jobs it lost since the start of the financial crisis in September 2008. Further, if one takes out the Texas growth out of the equation, the GDP growth also falls considerably. As Rhines writes “From 2007 through the end of 2013, the U.S. economy grew by $702 billion, and Texas grew by $220.5 billion.”
Other than this the broad unemployment numbers hide the fact that the labour force participation rate has been falling over the years. Labour force participation rate is essentially the proportion of population older than 15 years that is economically active. The number for September 2014 stood at 62.7%. This is the lowest number since 1978. The number had stood at more than 65% before the start of the financial crisis. Hence, more and more people are now not looking for jobs and they are no longer counted as unemployed.
Further, a lot of jobs being created are part-time jobs. Also, with jobs being difficult to come by many people looking for full-time jobs have had to take on part time jobs. In August 2014, nearly 7.3 million Americans were involuntarily working part time, compared to 4.6 million in December 2007, before the financial crisis had started. In September 2014, this number dropped to 7.1 million. Even after this fall, the number remains disproportionately high. This underemployment is not reflected in the rate of unemployment number.
Janet Yellen obviously understands this. As she had said in a press conference in September 2014 “There are still too many people who want jobs but cannot find them, too many who are working part-time but would prefer full-time work.”
Taking all these factors into account the Federal Reserve is unlikely to start sucking out all the money it has printed and pumped into the financial system any time soon. Nevertheless, whenever it gets around to doing that there will be trouble ahead.
Lanchester perhaps summarises the situation well when he says: “If a medicine is guaranteed to make you very sick when you stop taking it, and you know that one day you’ll have to stop taking it, then maybe you shouldn’t start taking it in the first place.”
But that at best is a benefit of hindsight. The horse, as they say, has already bolted by now.

The article originally appeared on www.FirstBiz.com on Oct 29, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)