Tag Archives: QE

The Debt Chickens Are Coming Home to Roost

A story it today’s Us print edition of the financial times highlights a building ‘bubble’ of disquieting proportions. The article, ‘Britain’s Pizza Chain Boom Faces Debt Reckoning’, highlights how a large number of restaurant chains have been snapped up over recent years using debt. This might be by a private equity firm or a leveraged buy-out. In either and other cases, many acquisitions were executed using cheap debt which was facilitated by central bank policies such as near-zero interest rates and quantitative easing (QE), both of which massively distorted the price of corporate bonds and debt. Add to this public policy and pressure on banks to increase loans to help drive growth, you can see signs of a perfect storm.

The UK example is specific, but the problem is wide and applicable to most developed economies. The US has just come off a long-run marathon of high and record levels of corporate acquisitions, again much funded by cheap debt. There must be many organizations hanging by a thread, just waiting for interest rates to nudge up resulting in unsustainable debt burdens and interest payments. Unless growth drives the top-line of these businesses at a faster rate, the chances are many such firms will go to the wall.

This situation was created as an unintended consequence of near-zero interest rates for such a long time and massively price-distorting quantitative easing. Though most governments have ceased buying sovereign and corporate debt, the damage is done. Massive, trillion dollar, balance sheets at central banks need to be unwound in such a way as again, not upset the market. The act of creating the balance sheet did upset the market. In reducing their balance sheets, central banks will do it again.

And the sad part about all this, as it will play out? Smart investors with lots of money and a high risk-tolerance will hedge against such business failures and reap huge rewards. The rich investor-class will get richer, and the poor will just lose their jobs or otherwise miss out. Politicians will have a field day, calling out the failure of capitalism. Of course, it’s not a failure of capitalism since central banks and their policies are not part of any capitalist model: central bank operations are closer to a socialist model where the few take decisions to ‘help’ the many, as if they know better and how to help us.

Oh well, such is life. Just buckle down and wait the storm. The debt chickens will soon be home to roost. Maybe not by this Easter but expect them home by next year.

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The Failing Fed?

The US print edition of the Wall Street Journal paints a picture today of the US Federal Reserve as it was a failing institute. The front page carries a leader titled, Fed Stumbles Fueled Populism and it is part of a series called The Great Unraveling. Not exactly an encouraging series title. But the main article is well worth reading. It certainly is fascinating stuff. Two comments quoted express the amazing situation we find our collective selves in.

‘ “I certainly myself couldn’t have imagined six years ago that we would be employing the policies we are now,” Fed chairwoman Janet Yellen said to a packed ballroom in New York earlier.’

This is in reference to near- zero interest rates, quantitative easing and asset purchases that had distorted the market totally.  

‘ “We should be extremely worried,” Harvard professor and former Treasury Secretary Larry Summers said: “We are essentially on a fairly dangerous battlefield with very little ammunition.”‘

This is in reference to the notion that the US economy is very likely passes its ‘peak’ and now moving down towered a ‘trough’. In many years past this should imply a contraction and possible recession. With near-zero interest rates the Fed has no ability to cushion any such contraction and thereby encourage recovery. The Fed can only further increase its balance sheet through new QE or ‘helicopter money’.

Bottom like folks, we are in deep trouble. Of all the economic crises we have seen, from hyperinflation in Germany, the breaking of gold, the inflation of the 70s, the Asian crisis, the recent financial crisis, this is just as risky but for reasons intrinsic to the systems and levers that are designed to avoid such crisis. This is what makes this time different. It is not external conditions that might trigger a crisis; its the very guides that are meant to save us hat might.

And as written widely before, high Fed policies did save the global economy some years ago, such polices had to persist due to the lack of concrete political action. Our political schism has created a void the Fed stepped into. The Fed is now stuck in the resulting mud and has no ability to get out.  

Can Central Banks Run Out of Things to Buy?

There was an interesting article hidden in the depths of yesterday’s US print edition of the Wall Street Journal titled, Could Japan’s Central Bank Run Out of Bonds to Buy? This is not as far out as it sounds. Of course, the question arises from the massive amount of “quantitative easing” Japan’s central bank has undertaken in the name of driving demand in a sluggish economy. The USA has done the some thing, the U.K. And Europe too. It has been the second weapon of choice for central banks once interest rates hit rock bottom, or even gone negative.

There is not much research that proves that QE actually drives economic demand. In fact, there is ample evidence that QE does not drive demand in an economy. In fact recent data points to how firms report that their treasury departments do not seek new investments to drive growth if interest rates are rock bottom or cash is cheap; they fund their plans that are based on other factors to do with their industr.  These same firms have though sold bonds and acquired loans in order to drive M&A and larger share buy-back schemes. Thus the invester class has gotten much richer while the rest of the middle class has not.

Such massive amounts of bond buying has created huge market distortions. The interest rate at which sovereign governments can offer bonds remains depressed as central banks swallow up larger and larger amounts of bonds. Such a large buyer in the market should crowd out private sector demand for the same bonds. To help spread the impact central banks, as in Japan, have expanded the definition of what it is the central bank can acquire in the name of QE, even to the point of including shares.

In a nutshell QE has not resulted in the behavior central banks sought. And now we are in a pickle. Central bank balance sheets are ballooning, and just as the business cycle passes its peak, central banks have little wiggle room to help smooth the downswing: interest rates remain rock bottom (for the US, they are a smidgen above rock bottom) and balance sheets are full. Even in the US, words of “normalization” does not yet include the Fed selling off its war chest of invested bonds. Such offloading will take years since its impact on the market will be huge: it would drive up the need for bond issuers to offer higher returns in order sell them.

So the question asked by the WSJ is not fanciful. It is a sad reflection of the times we are in.  2016 will be a challenging year for central bankers – as well as for the rest of us. The bad news for us is that we don’t get the chance to write a book after the story has been completed and make a million from that effort. 

Happy New Year to you! 

Tit-for-Tat: ECM to increase QE in response to Fed holding rate at zero?

There was a worrying report in the Money and Investing section of today’s US print edition of the Wall Street Journal.  In “Stronger Euro May Put Pressure on ECM“, Brian Blackstone suggests that, “[t]he Federal Reserve’s decision to keep interest rates near zero could put added pressure on the European Central Bank to step up its own stimulous efforts to keep the euro’s exchange rate from strengthening too much and derailing Europe’s fragile economic recover.” 

This is madness.  We cannot have uncoordinated tit-for-tat behavior between the US, Europe, China and Japan.  The four largest economic areas need to align policy if we are to get out of this mess.  This is not a free market: we have four very large monetary systems that are in lock-down mode.  Every decision in one quarter might seem to further the advantage of one region; and so another decides to act to preserve their own position.  This is a ‘race to the bottom’ problem that is holding global growth back.  We need either:

  • Central banks to be closed down in order for financial markets to re-settle at a new normal on their own
  • Central banks to coordinate policy globally so they can do the best they can to ‘raise all boats’.

The first option won’t work – though I suspect there will be increasing calls for this kind of idea.  Rand Paul is a fan already.  But the second idea has a chance, even if the the method reaks of top-down control.  The current efforts are competitive (yes) but we are watching the steering of very well centrally managed monetary systems in uncharted territory.  We either need free markets up, or provide better coordination.  If the ECB increases, for example, its QE program as a means to help the euro, you can bet either China, Japan or the US will respond, or the Fed will have additional doubts in Q1 2016 concerning rate rises again.

If this was not enough, here is another article that suggests the pressure now is on Japan to increase easing.  I have no other choice but to refer to my Open Letter to Christine Laguarde, head of the IMF, for a new Bretton Woods Agreement.  At this point we need more hard and firm collaboration in monetary poilicy, not tit-for-tat, race to the bottom competition.  

Where has all that money (from Quantitative Easing) Gone?

QE was a Fed policy to help rescue and then grow the economy.  Once the interest rate weapon had been exhausted – running at near zero and then zero – QE was the only remaining weapon left in the bag.  It was desgined to put money back into economy.  By flooding the market with money, and zero interest rates, presumably capital investment by private industry would swoon, production increase, and wages would be improved.  This has not happened.  Capital investment has remained meager, production growth has not taken place and wages have remained all but flat; in some cases even down in real terms.  So where has all that cash gone too?

With hindsight we can see several places where excess money has surfaced:

  • The investor class
  • Private sector balance sheets

And from these two prime sources we now see secondary sources that have recieved benefits:

  • A massive bull-run in the US stock market
  • Record breaking stock buy-backs, which increases EPS, that pays higher rewards to CEOs and boards, without actually leading to more competitive or successful businesses
  • Record breaking mergers and acquisitions that in some cases have led to re-ordering of industries.

In the US print edition of the Financial Times Sunday there was an article called, “Record Year in Sight After Week’s $50bn in M&A Deals“.  In a nut shell there has been a lot of M&A, funded by cash and debt, itself funded by QE and low interest rates.  Due to the significant amount of money sloshing around in the system you would expect that such prices for M&A are abnormally high.  If not, presumably companies that were not really in deep trouble are being snapped up.  So the normal cycle of creative disruption is itself being distupted.

Bottom line: QE has not worked as the Fed expected – see  “The Printing Press Rolls…” It has not worked either in EMEA, or elsehwere, for that matter.  Though other countries continue to be enamoured with the idea- See “Japan: The Great QE Experiment Fails“.  We are now stuck with a whole load of cash at the bottom (actualy, at the top, if you know what I mean) of the economy.  If inflation ever did get going, it might actually be hard to slow it down with normal interest rates recovery  The next phase of the expriment is about to be joined.  What happens when QE becomes quantitative tightening but that tightening takes two years to complete?