I have watched multiple iterations of quantitative easing methods and am increasingly alarmed by the ineffectiveness of Central Bank policies. Central Banks are bloating their balance sheets by competing with private citizens for assets thus lowering yields and forcing up asset prices in the hope that this will stimulate economic activity and increase inflation. Other than bailing out the world in the midst of the 2008 financial crisis I have seen no evidence that quantitative easing does anything other than inflate asset prices and as such is leading us into another crisis which may be even worse than the financial crisis of 2008.
Anybody who lived through the 2008-2009 time period probably knows the U.S. and world financial systems were very close to ceasing to work. Lehman Brothers failed and multiple other key financial companies and banks were on the brink of going bankrupt due to liquidity concerns. Unfortunately no matter how many "assets" one has, bills need to be paid in cash. Principal and interest payments need to be paid in cash. The banks and financial institutions held many "assets" that they thought could never lose value (or at least not lose nearly as much value as they did). Well, when there was a run on the housing sector this is exactly what happened. Housing values plummeted and the values of these assets (many of them leveraged to extreme levels) fell quickly and liquidity dried up. Our entire financial system, both in the U.S. and the world, is extremely inter-connected and when one large player fails to pay their debts it can cause others who rely on their repayments to repay others to also default. Well, the FED stepped in and provided much needed liquidity to stop the process from its downward spiral and introduced confidence where there was no confidence. In my opinion they saved the system from an even worse collapse. In late November 2008, the FED started buying $600 Billion in mortgage-backed securities to provide liquidity. By March of 2009 it held ~$1.75 trillion of bank debt, mortgage-backed securities and Treasury notes. They reached a peak of $2.1 trillion in June of 2010 and further purchases were halted as they believed the economy had started to improve and they had instilled confidence in the economy…..crisis averted, right?
In the FED's infinite wisdom they decided in August of 2010 that the economy was not growing quickly enough and decided to start "QE2" and buy ~$30 Billion in treasuries each month and a total of ~$600 Billion. Then when QE2 was about to end the FED quickly realized they didn't buy enough securities to "make the economy better" and they decided to implement "QE3" in September of 2012 much to the cheer of world financial markets. QE3 would leave the federal funds rate near zero and allow central bankers to buy around $40 Billion of securities monthly which in December of 2012 increased to $85 Billion per month. When the recession began the FED had ~$850 Billion of assets on their balance sheet, they now control over $4 Trillion in assets (Please see below chart from Heritage.org).
Central Banks around the world have followed the FED's lead and are now buying assets at an alarmingly fast rate. The BOJ is a top 10 owner of ~75% of the Nikkei 225 stocks. They are even projected to be the number 1 shareholder of 55 out of 225 Nikkei stocks by the end of 2017 as they continue ETF and asset purchases (Please see below chart from Bloomberg.com).
The BOE, ECB and other central banks are also continuing to purchase assets. They are purchasing so many assets that roughly 30% of the worlds government debt now has a negative yield. The ECB is even buying many corporate issues. As such they have helped many private companies such as Sanofi (NYSE:SNY) who recently issued EUR €3B at close to a zero yield. These policies are forcing consumers who want or need a return on their assets to make increasingly risky moves.
The real question is how does this all end? While I have no clue exactly how or when it ends, I would like to offer the following proposals.
- Central Banks buy all assets.
- Central banks stop their current policies and allow their bond purchases to run-off and able to successfully sell all their stock purchases.
- Consumers realize Central Bankers have no real control. Central Banks have purchased so many assets and inflated asset prices to unsustainable levels. There becomes a Minsky moment when everybody tries to dump overvalued securities and there are no buyers other than governments.
Obviously nobody can predict the future, but #1 above is probably unrealistic. It is also inconsistent with a capitalistic society. The definition of Capitalism is "an economic and political system in which a country's trade and industry are controlled by private owners for profit, rather than by the state." Although I believe central banks have already gone much further than a typical capitalistic society should allow for, buying 100% of assets is obviously not realistic.
I think #2 would have been a truly realistic possibility had the U.S. Federal Reserve not started QE2 or QE3 and allowed their balance sheet to shrink after saving us from the financial crisis. It also would be easier to suggest its viability if not for the BOJ and ECB's continued use of increasing amounts of asset purchases. They have effectively pulled out their bazookas even though in my opinion they were not and are not needed……so much for Adam Smith's invisible hand.
Number 3 is obviously the scariest outcome. With little to no economic growth all central bankers have done is to inflate their balance sheets as well as asset values in the years since 2009 through asset purchases. There have been many instances in history of times when asset values didn't properly align with economic conditions, most recently in our U.S. history the internet/telecom bubble of the 1999-2000 and the housing bubble which led to the financial crisis of 2008-2009. There was also the Dutch tulip mania in the 1600's and the British South Sea Bubble of the early 1700's and many other countless bubbles. I believe the scenario today is even worse than those previous bubbles. If the financial crisis of 2008 was caused by low interest rates in the years preceding it which spawned the bubbly housing market and the reach for yield and use of leverage, what new troubles will today's ultra low rate environment bring?
If there becomes a moment when people cease to believe in central banks ability to control monetary policy people could also cease to believe in fiat currency. After all, since central banks have been effectively printing money to purchase and inflate asset values, what is the value of a piece of paper called "money"? The government can just print more and buy everything and solve all the problems with no concern for consequences. Well, confidence is a funny thing. In 1999 people couldn't buy enough internet stocks and then mysteriously the bottom fell out from 2000-2003. Also in relation to housing, everybody was buying housing in 2003-2006, prices could never go down and it was the best way to make money, everybody was doing it. And then nobody could sell anything and liquidity dropped and the government had to clean up the mess. What happens if central banks have a Minsky moment where trust is lost in today's world with central banks over-leveraged? Do they continue to buy assets and print more money? What if the market no longer believes central banks can control asset prices? It could be the collapse of the modern day financial system as we know it or at the very least a very long fall from where we are at today.
My only advice is to be careful out there and know that confidence in central banks ability to continue to support the world's economic system and inflate asset values is the only thing holding it all together. If this confidence falters, it could happen very quickly and be very scary. I am not hoping this happens nor would I be happy if this came to pass, I just want to make sure people understand the risk they may be taking in todays world of central bank binging. I will leave you with one last picture which I believe speaks volumes about the level of central bank intervention (Source Link). Best of luck to all!
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.