Sunday, October 27, 2013

QE: one has to question

If we consider the financial sector a useful prop to the real economy, as opposed to a sector existing for its own sake, then the acceleration in the level of speculative activity relative to underlying GDP in the run up to the crash of 2007 could be viewed as a useful heads up to the risks that were brewing.

When everything went to ruin, "unfettered capitalism" became the central scapegoat and policy makers felt licensed to intervene wherever possible, and as much as possible - you know to "maintain the order of things" and protect everyone from themselves and for the common good and because the risks were too great to do anything less and because of this, and because of that. We saw the largest fiscal stimulus package in US history, supported by Republicans and Democrats alike.

We also saw the introduction of a massive market distortion mechanism called Quantitative Easing (QE) whereby the Federal Reserve purchases $85bn of bonds each month, thereby flooding the financial system with liquidity. The hope was that this money would percolate through the real economy and support the recovery. Broadly speaking, it hasn't been very effective in this goal.

One now has to question the strategy and the Fed's reluctance to pull back from the programme even incrementally, especially seen as the liquidity flood has clearly exacerbated inequality by inflating financial assets (bonds directly, and equities and commodities through a second order effect), which are on balance held by the rich and not the poor. Oh, not to forget the booming housing market.

As the equity markets hit new highs on the back of expectations of Fed tapering being pushed out into next year, I do wonder if the fragile rally will crack, making the policy maker's decision look like folly. A clean escape from the greatest monetary experiment of all time might not yet be impossible but I fear the probability of a clean escape outcome diminishes by the day; indeed it is with the passage of time that the markets view this support mechanism as an ongoing and dependable lifeline. When it looks like the life line is being pulled away, the patient will scream and wail all the more.

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