By now, we probably all know central banks around the world have conducted/are currently conducting QE at an unprecedented level, as a percent of GDP or public and private securities holdings. And now with The Federal Reserve and Bank of England (BOE) hinting at quantitative tightening in the next quarter or two and European Central Bank (ECB) perhaps in the next year or two (who knows when with all the evident populism and EU banking challenges!) and BOJ to perpetuity, at least that’s the direction now, let’s look at the effectiveness of the QE program and its impact on the economy post-crisis.
QE was officially introduced all around the world in great part to stimulate the economy after the 2008 slowdown, in which, on the top level, has accomplished much from the perspective of employment and business activities. However, one has to question the “effectiveness” of the program. However, if you look at the chart below, the red line is the monetary base (aka the $ from Fed to the private sector) has increased by 357%, while money supply and bank credits have only grown by 63% and 21% respectively. This could be one of the many theories why inflation has yet to reach 2% because all the capital made availability did not translate with great efficiency to the credit and therefore economic cycle.
Monetary base can grow to whatever the central banks desire but what is really pushing the true short-term economic cycle is the availability of credits (at least based on what we have experienced in this past century thus far) for the private sector and part money supply in our economy. The availability of credits allows private companies and individuals to borrow and create new business opportunities therefore contributing to the economic bottom line. Base on the chart below, we can conclude with a decent certainty (though nothing is certain thanks to Nassim Taleb’s Black Swan or if this case, white swan), that the extensive quantitative easing have not translated to a high degree of economic growth. As you infer from the chart above provided by The Federal Reserve and Nomura Research Institute, QE is not that effective after all, relatively speaking, in terms of injecting credit liquidity to the US businesses (even while companies like Restoration Hardwares have essentially bought back 50%+ of their shares on the market in the past few quarters alone, therefore implicitly increasing the EPS by a factor of 2).
However, what has been done has been done but it would be interesting to follow how private banks will adjust to the incoming quantitative tightening, known as QT by mainstream media. QT essentially takes back the liquidity, though from the banks and therefore, to some part from the economy. But what has yet to be worked out based on what has been announced to the public, is whether the liquidity absorption will be coming from the money supply, credit and/or monetary base and if so, how much from each bucket. QT will essentially cut the credit extension from the public government sector which isn’t too bad if the credit extension from the private sector can fill the gap.
Below is a chart of how we got out of the Great Depression via credit extension to different sector of the economic structure. In June 1929, credit extension to the private sector presents an over-leverage situation and credit extension to the public sector was miniscule relative to the asset side of the US balance sheet, as a result, became of the many catalysts of the economic slowdown. They then shifted in 1936 in which credit extension to the public sector, similar to the quantitative easing of my generation, increased substantially more, relative to 1929 pre-depression.
In October 2017 onward, the Federal Reserve will engage in quantitative tightening in which credit extended to the public sector will dry up incrementally (which by itself does not have much implication) but the question comes whether the credit extended to the private sector can fill the gap or more and furthermore, how our economy and as a result, the equity market will react once this monetary base strategy has kickstarted in along with the increasing interest rate in the coming quarter or two?
Bear in mind this article is just focused on quantitative tightening, one of two major strategy pillars of the Federal Reserve going forward, and we have yet to examine the potential implications of the increase in interest rate, one in which almost all financial instruments around the world is directly and indirectly hedged on (this could perhaps be partially why managing the monetary base precedes that of the interest rate increase) *hint* Australia and Canada mortgage rate + high yield.
It’s easy to criticize after the fact so I try not to criticize the Federal Reserve’s QE policy implemented during the recession (thanks to the study of philosophy), perhaps this is what they had to do given that moment in time, but one has to bear the question of whether QT along with increasing interest rate on the economy will exasperate any potential catalysts. QE essentially increased the monetary base but even though it doesn’t translate 1:1 to the availability of credit to the private sector, there’s still substantially more credit relative to the month post-crisis. QT on the other hand, absorbs the already-limited credit availability for the market, all while the increasing US consumer debt delinquency rate is working great wonders as well.
Let me know what you think in the comments below or PM! In the next few articles, we will examine different scenarios, similar basis in JP, EU and UK.
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