The End of Quantitative Easing (QE) Could Spell Economic Collapse
The Fed plans to remove $4.5 trillion in liquidity from the financial markets. Will it—can it—do so without reducing the bonds and stock markets to an equally unimaginable number of shreds? Much uncertainty surrounds the Federal Reserve’s response to rising interest rates all over the world and the falling dollar. There’s no doubt that the Fed will sooner—or later—dump Quantitative Easing (QE). At that point, nothing short of economic collapse could occur.
The Fed, if you hadn’t noticed, has been abnormally injecting money into the economic system. It has bought financial assets in unusual quantity. Terminating this practice won’t be easy and it won’t be cheap by the Federal Reserve because it’s a move surrounded by much uncertainty. The only certainty is that if the Dow has reached the 22,000-point mark, it owes this record squarely to QE.
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Thus, the Fed’s liquidity injection has prompted an extraordinarily accommodating cost of money for the past nine years of so-called economic recovery. After the Fed shuts the tap of liquidity, it’s anyone’s guess how long this will remain true before economic collapse—or a major stock market crash—occurs.
Predictably (and who can blame them?), Fed officials are trying to minimize their importance. But how long can Janet Yellen keep the semblance of calm? The mere hint of a hike and bearish sentiment will smother the bull market like a California forest fire.
The Fed Cannot Keep QE Much Longer
Certainly, the Fed will normalize rates, but few have really understood why it cannot sustain the current practice. Maybe this number might help: $4.5 trillion. Between 2009 and 2017, the Fed has fueled a gargantuan level of liquidity. (Source: “Goldman: Banks win, companies with high debt lose from Fed’s upcoming historic move,” CNBC, September 18, 2017.)
This liquidity was used to buy financial assets. To understand the scope of this figure ($4.5 trillion), imagine spending $100.00 a second, 24 hours a day. It sounds like a lot, it’s $6,000 a minute or $360,000 an hour and well, you get the picture. It would still take several decades, even spending at that rate, to exhaust $4.5 trillion. But, it’s that kind of cash injection that has encouraged the market bull run.
In short, it’s a lot of money, spent over a period of about nine years, and nobody should be surprised by a price distortion in the market from stocks to bonds. Though, I shall limit the argument here to stocks and to the real economy. Indeed, has QE helped the real economy?
The first doses of QE injected liquidity into the economy at a time when the banking sector was reducing its influence. Or, rather, it was tight with credit, slowing down any chance of recovery. In this sense, QE did improve the Federal Government’s’ ability to borrow. The lower interest rates allowed the government to endure a cheaper deficit. Of course, when Janet Yellen pulls the interest rate trigger again, U.S. national debt (already at $20.0 trillion) will be harder to manage.
By lowering the interest rates to zero—or close enough—any Treasury Department earnings that the Fed made through its bond portfolio, which could spend at will without having to worry about interest. Ultimately the reduced interest rates were intended to encourage economic growth by making private sector credit more convenient.
As for families, the QE was supposed to have stimulated spending and consumption, despite notable drops in real wages. Perhaps, it worked at first. It protected the more vulnerable societal categories from the worse aspects of the financial crash of 2008.
The Economy Has Grown But the Bill Will Be Shocking
In effect, economic growth has improved since 2009, as well as the markets, but no central bank can keep that kind of liquidity forever. The past nine years of QE represent an unprecedented experiment. It may have worked partially, but QE is about to present the bill and it could send the economy and the markets in shock mode.
That’s as far as the government and national debt considerations go. But what about the private sector, did they benefit from access to cheaper credit? Again, in the short term, QE has benefited businesses that were struggling to cope with the effects of the 2008 crisis. But, in the long term, the extended period of QE has inspired dangerous practices, which are all going to come to head as interest rates return to reality.
QE has encouraged “financial engineering” to the detriment of investment in the real economy. Therefore, it has reduced the future growth of productivity. Economic Darwinists may also complain that QE has allowed deadwood businesses to stay alive. Weak companies have survived, affecting the economy’s future growth potential.
Has QE Helped the Average Citizen?
Now, the ultimate question. Has QE helped individuals and families? After all, even the banks are operated by people who have mortgages, children’s education, and car loans. They also must pay for the food that goes on the table. In this case, given the benefit of hindsight, the answer is a resounding NO.
Governments, households, and businesses are now more indebted than pre-crisis levels. And this makes the system potentially very sensitive to higher interest rates. And, consequently, more fragile. “For the time being, most observers agree that the EQ benefits outweigh the potential costs and risks. It remains to be seen whether this will remain true once the Fed will normalize its budget. “
