In my last post I acknowledged that there is a difference of opinion about whether the US Fed’s unconventional monetary policies were the best the Fed could do under the circumstances, or whether the Fed is itself the cause of the long, slow recovery from the 2008 Financial Crisis.
I pointed out that 313,000,003 Americans believe the latter, while the former is believed by Congress(1), the financial industry(2), and global opinion leaders.(3)
The disagreement stems from the fact that we have had only one example of an important economy that used QE, and that economy happens to be the most powerful in the world, pretty generally able to survive even the most asinine central banker ideas. However, we are about to have two more examples, and these, I predict, will resolve the disagreement once and for all, much to the misfortune of Congress, the financial industry, and people who used to be global opinion leaders.
The second example is Japan, where the BOJ in the spring of 2013 launched a QE program that was much larger than the US Fed’s, relative to the size of the Japanese economy. Like the Fed, the BOJ intended to push core inflation up to its 2% target and get the Japanese economy growing again.
Two years in, how are our friends in Japan making out? The answer is “lousy.”(4) The most recent core inflation marks in Japan (January 2015) show inflation at (are you sitting down?) 0.5% and falling. And the Japanese economy is a disaster. After remaining in recession in 2013, Japanese GDP grew nicely during 1Q14, but then the economy collapsed in 2Q14, with GDP declining -7.3%. True, a large sales tax increase was blamed, but growth continued to be negative in 3Q14 (-1.6%), throwing Japan back into recession.(5) At the same time, the decline in the value of the yen, thanks to QE, brought foreign investors into Japan’s real estate market, making it nearly impossible for domestic buyers to buy homes, condos, or apartments. Nice going, fellows.
But surely, you are thinking, the Japanese stock market must be going up, so at least rich Japanese and foreign investors are happy. Nope. Americans will buy stocks at the drop of a hat, of course. (Say the words “Janet Yellen” and most red-blooded Americans will already be speed-dialing their broker.) But the Japanese think differently. They don’t much cotton to stocks and would rather put their money into something solid that central bankers can’t screw up so easily.
And as for foreign investors, after watching the dismal effects of QE in Japan for two years, they are staying away in droves. In the first three weeks of January 2015, for example, the BOJ bought 334 billion yen worth of ETFs, while foreign investors were selling a net 817 billion yen worth.
In short, far from making inflation and the economy better, QE in Japan has acted like a sucker punch to both. But when you point this out to the QE-lovers, they will roll their eyes and tell you, sotto voce, that, well, the Japanese are different. Personally, not being a racist myself, I take the opposite view and point out that the US and Japanese experiments with QE have had identical results: dismal.
Still, at this precise moment we have, in the eyes of the QE-lovers, one positive example of QE (the US) and one negative example (Japan). Unfortunately for Fed fans, we now have the ECB getting off its duff and following, lemming-like, the Fed and BOJ off the cliff.
In late January the ECB announced that, beginning in March, it will launch a massive QE program. Here’s what will happen in Europe, a prediction we can have great confidence in because we’ve already seen it happen in the US and Japan: nothing. Inflation will stay about where it is – and certainly will remain far, far below the ECB’s 2% target. Economic growth will continue at about its current abysmal pace (well under 2%, probably worse). And the stock market will go up, albeit not as far or as fast as happened in the US.
At that point, the days of denial will be over. It will be clear to everyone that their faith in the central bankers was misplaced. If you pump up the prices of risk assets, you must also pump up the underlying economy so that prices can, in effect, grow into themselves. The Fed managed the first part of this trick – pumping up stock prices – terrifically well, but it forgot about the second part.
At that point the chaos occasioned by the actions of the Swiss National Bank will appear to us as nothing more than, as the Japanese like to say, “a tsunami in a tsushi roll.” Hapless investors will wake up and discover that they are standing on a very high cliff and that the real economy lies far, far below. A pandemic of acrophobia will sweep across the financial landscape, compounded by investment vertigo. As they watch their net worths disappear sickeningly into the void, investors will say to themselves, “We should have remembered Curtis Investment Proverb No. 36: Never Trust a Central Banker.”(6)
(1) Because the Fed’s antics allowed Congress to do nothing about the US economy, which it promptly did.
(2) Because the one thing everyone can agree on is that those of us who were already well-off got a lot more well-off thanks to the Fed’s pumping up of stock prices.
(3) Global opinion leaders, I’m sorry to report, are everywhere and always reliably wrong about everything. This is because of (a) GroupThink: if an opinion leader inadvertently develops an opinion that differs from that of other opinion leaders, then he is by definition no longer an opinion leader and should go back in his hole; and (b) lack of perspective: since opinion leaders have the attention span of a hangnail.
(4) It’s actually rather odd that the BOJ would have imagined that QE would work, given that they had already tried it between 2001 and 2006 (the world’s first QE program) and nothing happened. That QE program “failed to rid the world’s third largest economy of its persistent deflation,” (The Guardian, 1/22/15), and, according to a study by the Federal Reserve Bank of San Francisco, there was “little evidence that quantitative easing stimulated overall lending activity,” and that QE “may have had the undesired impact of delaying structural reform.” See Mark M. Spiegel, “Did Quantitative Easing by the Bank of Japan ‘Work’?” FRBSF Economic Letter, October 20, 2006.
(5) GDP results for Japan for 4Q14 weren’t available at this writing.
(6) Wondering what you should do to protect yourself? See my next post.
Next up: A Dark Harbinger? (Part 4)
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Please note that this post is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.
