We are entering new economic and investment territory – An introduction to QE, what does it look like and what does it mean for investments?

Welcome to Finance and Fury

We live through transformational times – new environment for finance and investing  

1. We are fast reaching the limits of monetary printing – markets are still trying to work out how to price that in
   1. Past model – print money
   2. Get GDP growth through aggregate demand increase – mainly consumption
   3. Therefore – due to velocity of money (turnover) – get multiplier effect – more times money changes hands the bigger the effect = $1 might lead to $3.2
      1. Trouble is that turns out inflation is mostly driven by behaviours/psychological phenomenon
2. GDP growth, inflation, productivity are all missing in action despite 9 years of declining rates and 6 years of monetary doping and financial engineering the world over.
   1. If you increase money supply – money needs to go somewhere – sometimes through existing off investment managers or pension funds or new bonds issued from the bank
      1. RBA will give CBA $1bn of newly printed money – in return gets CBA Bond to the value of $1bn with a coupon
      2. Bank uses new money as deposits to fund further lending – leading to more economic growth through increased consumption – then we are meant to get inflation –
      3. Found to be very ineffective – UK QE = £375 billion of new money just to create £23-28bn billion of extra spending in the real economy
         1. Over time reduces growth if money went into mortgages – lowers spending due to larger loans to repay as borrowing capacities rise as rates drop due to this policy
3. No positive outcomes have led to falling credibility of Central Bankers, as they ran out of policy space
   1. Falling credibility is typical precursor to imbalances compounding (including bubbles)
   2. Creates a lack of confidence – and becomes its own tipping point for a financial crisis.
4. Yet – Australia – Lowering rates – calls for QE – Quantitative easing – printing money for liquidity
   1. Officially – known as large-scale asset purchases through using newly created money
   2. Type of monetary policy– an extreme one – where a central bank creates a policy to buy predetermined amounts of government bonds or other financial assets in order to inject liquidity directly into the economy
      1. Purchase of bonds and assets (life ETFs) –
      2. To inject liquidity – money to be spent – money terminology very similar to maritime/water –
5. Trouble is that there is a lot of evidence that this policy type won’t work – just leave with money to pay back

What this means for the market

1. Without growth and inflation from here – future for market economies looks very different – want to spend a few episodes to run through
   1. Looking at the past – economic change has occurred a lot – financial system has had its resets
   2. 1920’s – structural deflation led to Keynes revolution in economics
   3. 1940’s –world fully abandon gold standard to a semi- gold backed system
   4. 1970’s – chronic inflation led to Milton Friedman counter-revolution, and governments like Thatcher or Reagan
2. Market-based economies survived these – what has changed – we are in a new form of global capitalism
   1. Entangled things – Financial System is Global – no longer is it nationally important – look at GFC (US banks) = 68% loss on the big 4 here
   2. Accelerated things – the industrial revolution took years to equate to growing productivity and wealth, while it went through its implementation phase. Industrial and aggregate productivity growth slowed down markedly in the years 1890 to 1913, as we moved towards the second industrial revolution
3. What has been true in every case – Deflation is like a death penalty for debt-laden economies
   1. Low rates decrease service costs on debt, but negative inflation rates increase its real burden, leading into more debt-deflation.
   2. Now that interest rates and inflation are below zero, the economy is cornered and time is running out.
4. From here – Central banks hope to see GDP reverting to the mean, inflation to spring back up – wishful thinking
   1. Debt overhangs, bad demographics, chronic oversupply, technological disruption all conspire to the deficient aggregate demand, the structural deflation and the liquidity trap we see the world over.
   2. If inflation and nominal GDP cannot be resurrected soon enough – the bubble in markets will eventually bust
      1. Asset prices drop, economy stagnates, and discontent will trigger a change of regime into populists’ parties, for them to try what current politics could not.
   3. Major issue in a lot of countries – France and yellow vests, china/HK, India people protesting over banks

Existing examples for an economy with years of QE 

1. Japan: living laboratory for the Great Policy Experiment – One such place where experimental policymaking may be tested is Japan.
   1. Japan is likely to be the laboratory where new forms of crisis policymaking are implemented.
   2. Japan is likely to lead the way. It is the pinnacle of desperation after 26-year long unfruitful attempts at re-igniting growth and inflation.

There are a few reasons why Japan is desperate enough to be forced into pioneering innovative policymaking:

1. Exhausted effectiveness of monetary printing – QE – printed almost $800bn p.a. since mid-2013
   1. monetary base having grown to be as large as in the US – with an economy of 1/3rd the size – 0.5% real GDP growth in first three years but contracted by 0.3% in the last year
   2. money multiplier and velocity of money have been on free-falls – new lows = Inflation was negative in April at -0.3%.
2. Currency headwinds – JPY strengthened by 10% against the USD and other trade partners = lower exports = lower GDP
3. Cash hoarding problem – negative rates and new tax regulation = households are stashing cash under the mattress
   1. a 17% increase for physical cash year-on-year – demand for cash is deflationary – when demanded for savings = lower velocity of money – lower multiplier effects and less GDP growth
   2. Hence why governments are slowly working towards cashless societies – avoid Japan example

The Market Economy going forward: an illustration exercise

1. Big disclaimer – transformational markets are something that cannot be 100% predicted – no way to know where it will end up
2. But will look at possible outcomes – look at what is out there – what the economics are advising Gov to do
3. A new evolutionary phase of combining QE, deficit spending, and ‘helicopter money’ – the nuclear fusion of monetary and fiscal policies – might well be the next stop for policymakers, as they move from price setting to direct resource allocation, in certain markets more than others, in certain places sooner than in others
   1. Helicopter drop is an expansionary fiscal policy that is financed by an increase in a economy’s money supply. It could be an increase in spending or a tax cut, but it involves printing large sums of money and distributing it to the public in order to stimulate the economy
   2. Funded through deficit spending – so Gov issues bonds to fund spending – more debt every year
   3. Money to spend/buyers of bonds are the Central Banks by more QE – in perpetuity
4. Economic theory will change as well – flavour of the day to guess again what is best
   1. New economic paradigms (a new Keynes coming up? A new Friedman?) – Modern Monetary Theory or Modern Money Theory is a heterodox macroeconomic theory that describes currency as a public monopoly for the government and unemployment as evidence that a currency monopolist is overly restricting the supply of the financial assets needed to pay taxes and satisfy savings desires
      1. This is where the concept of UBI has its roots – helicopter money through printing money
   2. accidents along the way (deep deflation, hyperinflation, default events etc)
   3. political shifts (populist parties winning over, from the US down) – need Govs to promise this
5. Want to explore what the market economy going forward may look like – plausible scenarios based around current trajectory
   1. Work off a trend of what has occurred so far in policy – attempt to piece it together in a coherent manner
   2. No timelines on this – may happen in 12 months, few years, or never
6. Doesn’t take a genius to see that unless inflation and growth are resurrected – bad things happen –

To get that – run through main components of the market economy going forward

1. Permanent QE
2. Lowering rates and moving towards cashless economy to avoid BOJ situation
3. Fiscal expansion – Government spending – redistribution
4. Helicopter money
5. Abandon the dollar – IMF SDR – new reserve digital currency

Start breaking this down in the next ep on Monday

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