The Limits of QE (“Quantitative Easing”)
I’ll tip my hat to the new constitution
Take a bow for the new revolution
Smile and grin at the change all around me
Pick up my guitar and play
Just like yesterday
And I’ll get on my knees and pray
We don’t get fooled again
Don’t get fooled again
–The Who; “Won’t Get Fooled Again” lyrics
What caused the stock market to tank at the end of last week?
Certainly, earnings misses by Google, IBM, and Microsoft didn’t help.
And stocks, which have been strong the last 2-3 months, were arguably overdue for a pull-back, anyways.
But, I’ve got another theory: the markets are bumping into the limits of Quantitative Easing — or already have.
If you’ve been asleep the last 15 years or so, here’s what you’ve missed:
â€¢After the Internet/tech stock bubble crashed in 2000, the Fed dropped interest rates to the floor to stimulate the economy;
â€¢It worked (and then some!). Housing prices grew into a giant bubble, abated by Wall Street’s role “securitizing” — bundling — trillions in mortgages, and selling them to investors globally.
Unfortunately for everyone else (if not itself), Wall Street got a little, shall we say, “sloppy,” especially towards the end.
â€¢Surprise, surprise! Bubble #2 inevitably burst, taking housing and the economy down with it.
The Fed’s response?
â€¢Even cheaper money — after, of course, throwing a couple trillion at Wall Street to make it whole and putatively, save the financial system.
The All-In Fed; “Helicopter Ben”*
Which brings us — almost — up to today.
When the Fed realized that its policy of ZIRP (“zero percent interest rates”) wasn’t doing the trick this time around, it resorted to even more aggressive, ad hoc monetary steps to stimulate growth.
Like introducing so-called “Quantitative Easing,” essentially the Fed buying debt issued by the U.S. Treasury, ballooning the Fed’s balance sheet.
And engaging in “Operation Twist,” an effort to manipulate the relationship between short and long-term interest rates.
Then repeating Quantitative Easing twice more since 2010, to support flagging financial markets.
And issuing periodic pronouncements promising to extend aforesaid monetary stimuli even further into the future (I believe the Fed has now officially committed to ZIRP until . . . Kingdom Come).
Sowing Seeds of Its Own Destruction
Which leaves us exactly where today?
I’d argue that Quantitative Easing is subject to diminishing returns, which we’re seeing now.
That’s because QE contains within it the seeds of its own destruction.
Ironically, to the extent that previous QE’s have succeeded in boosting prices for assets of all kinds (stocks, bonds, commodities, etc. (not to mention gold, up 10-fold(!) in a decade), it increases the risks for later speculators, er . . . investors.
That’s what makes bubbles so risky — and dangerous.
After seeing the Fed stand by — if not encourage — two of the biggest bubbles in history the last decade-plus, perhaps, just perhaps, investor-types are wary of getting burned by a third one.
To paraphrase a certain famous saying, “fool me twice, shame on you. Fool me three times . . . shame on me.”
*“Helicopter Ben” dates to a speech then-Fed Governor Bernanke gave in 2002, suggesting that, if the Fed ever found itself combating deflation, and none of its other tools worked, it could “always drop money out of helicopters.”