Tuesday 21 November 2017

QE used as a policy mainstay but it may be doing real harm

James Saft

WHEN it comes to creating inflation, bond buying by central banks may actually ultimately be counterproductive.

Called quantitative easing (QE), it continues to be a mainstay of the policy reaction to the ongoing economic malaise. Yet here we are five years later and the evidence that QE can kindle inflation, much less revive the economy, is decidedly mixed.

In part that may be because everyone realises that QE isn't forever: ultimately the bonds the bank buys will have to be repaid. It is also true that QE can cause bad investments, which ultimately must be deflationary.

With US inflation rising just 1.2pc year on year in September, well below the Fed's 2pc target, bond buying by the Federal Reserve will continue – a bit like the old joke about beatings carrying on until morale improves.

Very radical increases in bond buying in Japan under Abenomics – more or less a pledge to buy and buy assets until inflation reaches 2pc – has also had only mixed success so far, with core inflation flat in the year to September.

That this, the first time Japan core inflation hasn't fallen outright since the end of 2008, is seen as a victory is itself a bit of an indictment of extraordinary monetary policy.

Dangerously falling inflation in the eurozone has prompted calls for the European Central Bank to join in the bond buying, despite its signal lack of success elsewhere.

The ECB is arguably already engaging in QE as its programme of providing long-term financing to banks often leads to banks buying government bonds themselves.

So, QE everywhere, and everywhere unsatisfactory inflation and at least the threat of falling prices.

Could there be a relationship? Part of the failure of QE may be explained by the fact that as a percentage of broader money supply the amounts involved are small. Banks must lend and businesses invest or QE will be swamped.

In some ways, all of the inflationary effects of QE are short-lasting and liable to be reversed. Not only is everyone involved aware that ultimately the bonds are not being bought and burned, but bought and held, and thus must be repaid or will be sold by central banks.

Also, QE encourages private investors to gamble a bit, perhaps leading to poor choices.

"Unproductive investment is by nature ultimately deflationary," Michaela Marcussen, global head of economics at Societe Generale, wrote in a note to clients. "This is a point also worth recalling when investing in paper assets fuelled by QE liquidity and not underpinned by sustainable economic growth."

And this brings us to the quite remarkable boom in initial public offerings, particularly in technology.

Twitter, that 160-character microblogging wonder, raised the top end of its IPO price range by 25pc on Monday. The company may end up being valued at almost $14bn (€10.4bn), or about 13 times revenue. Not 13 times earnings, but 13 times revenue.

For comparison, Boeing, which makes airplanes rather than selling ads against tweets, fetches a bit more than one times sales. Microsoft goes for about 3.5 times sales.

Pinterest, an internet service which allows users to post pictures and other media, raised $225m recently in a private deal placing a $3.8bn value on the company.

That's $158 for each of its 24.9 million users. I can't give you a price-to-revenues figure because Pinterest has never reported revenues and very well may not have any.

Clearly Pinterest and Twitter are growth companies, and may well repay their investors with future actual profit derived from honest-to-God revenue. But there can be no guarantees.

Things feel a bit bubbly and the problem with bubbles is at least two-fold. In a bubble, people build and invest in things which aren't themselves needed and ultimately don't create genuine revenue and growth. Think of all the rotting houses in Florida during the crash, or the empty cities of dusty apartments and stores in China (which themselves are arguably the fruit of QE).

Those investments were stimulative for a while, but ultimately highly deflationary.

In different ways, though by different paths, the same thing may prove to be true about investments made now during the time of QE. All debts ultimately must be repaid, defaulted upon or forgiven. Not much progress has been made on any of those three scores. (Reuters)

Irish Independent

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