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. We’ll report back next week on what we learned…
QE for Zombies
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 Fed 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?
Look Out for Falling Earnings
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?
Tune in next week…