Is QE Broken?

We’ve come to the charming city of Kilkenny in Ireland to speak at Europe’s first economics festival: Kilkenomics. What exactly an economics festival is we don’t know.

But according to the man who runs Kilkenomics, Irish economist and author David McWilliams, it brings some of the world’s leading economists, financial analysts and media commentators together with some of Ireland’s sharpest standup comedians…and has been described by The Australian newspaper as ‘Davos with jokes‘.

Bonner & Partners editor-in-chief Chris Hunter will be there too.

Chris has been explaining to members of our small family wealth advisory service, Bonner & Partners Family Office, exactly how QE works and doesn’t work.
In short, QE lowers interest rates. But the excess bank reserves that the Federal Reserve creates in return for the bonds it takes off commercial banks’ balance sheets don’t feed directly into the money supply.

These reserves don’t ‘leak out’ into the wider economy. Instead, they sit on deposit with the Fed earning interest.

But that doesn’t mean QE is benign. Because by reducing interest rates to near zero, it is shifting huge amounts of money from the productive sector to the zombies.

Savers have their earnings clipped by artificially low interest rates. But zombies – the government and its cronies – get money at unusually low rates.

The financial sector is getting richer, too. Stockholders and speculators are making money even as the real economy is limp. And corporate earnings – once you take away the boost from artificially low interest expenses on corporate debt – are poor. It’s no coincidence that the US stock market has been making new all-time highs as wages and disposable family incomes slump.

But what QE is NOT doing…so far at least…is lighting a fire under the real economy. Whisper it, but real US GDP growth forecasts have come down from 2% at the start of the year to 1.6% currently.

Think about it. If the economy were warming up, you’d see consumer prices (not just asset prices) rising. But we see no such thing (making an allowance for the fact that the numbers from the BLS can’t be trusted for a minute). The latest reports show consumer price inflation going down, not up.

Check out commodities. After hitting a high in April of 2011, the Thomson Reuters/Jeffries CRB Commodity Index – which measures the direction of commodities prices – is down more than 25%. And over the last 12 months, the official CPI has increased 1.2% – well below the Fed’s target of 2.5%.

And look at what is happening in Europe. The rate of consumer price inflation has just fallen to 0.7% – the same as Japan. In fact, it is back to levels last seen in the depths of the deflationary de-leveraging of 2009.

Even at boosting asset prices, QE is proving less and less effective. Since May, the S&P is up two percent. But during that time, the Fed has bought $500 billion of bonds via its QE program. Half a trillion dollars and all we got is a lousy 2% gain?

Hmmm…. What to make of this?

First, forget about tapering off. Instead, think of tapering on.

How about this as a possibility? With no more ginned-up earnings from ultra-low interest expenses…no boost to top-line revenues from rising consumer spending…and no pricing power – corporate America’s earnings begin to fall.

QE or no QE, stock prices fall. The Fed panics. It will be confronted with dropping asset prices and disinflationary (possibly deflationary) consumer prices. It will have to find a way to modify QE so that it does put dollars directly into the economy.

Second, this new push – if it comes – may well send stocks soaring again. There’s nothing like free money to make investors happy.

Third, the entire project is doomed. You can’t increase real incomes or the real value of businesses by pushing down some prices (interest rates) and pushing up others (asset prices). All you can do is make a bigger mess of things…and create new bubbles that inevitably blow up. And this time with no more faith in central banks’ abilities to fix the problem.

But how does it work, exactly? When does all this QE…low interest rates…deficits…pulling, prodding and pinching the economy…and all this nonsense finally go BOOM?

Stay tuned.


Bill Bonner
for Markets and Money

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Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America's most respected authorities.

Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and MoneyDice Have No Memory: Big Bets & Bad Economics from Paris to the Pampas, the newest book from Bill Bonner, is the definitive compendium of Bill's daily reckonings from more than a decade: 1999-2010. 

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3 Comments on "Is QE Broken?"

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steve in York

I wonder if the feds will go back to issuing checks to people directly as GW Bush pushed in 2001? Of course the asset price inflation that follows may not be what the fed wants – they sooo need to be in control. Would people take that money and pay down debts or buy silver or gold? Maybe the risk is too high that people may finally see their rigged game and not play anymore.

slewie the pi-rat
here is some amateur stand-up: between 2004 and 2006, your banks’ foreign borrowings to fund Irish mortgages rose from 10% to 41% of GDP, in two years! (a few titters) in 2006, Ireland had 6.2% GNP growth! (the people who are partying @ the punch-bowl start laughing) you’ve heard about the ‘wealth effect’? (hoots) well, in Ireland, that comes right before the ‘wealth TRANSFER effect’! (HaHa! now, we’re rolling!) what did you think, then, when some degenerate, fringe space-case in a tinfoil hat started raving about bankster conspiracies? (put on tinfoil hat and roll wide eyes while twirling finger @… Read more »
justin king

Considering that QE is now going worldwide, Currency Wars by Jim Rickards, is more applicable than ever.

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