Part I explained what is really going on with “QE”. It’s dry stuff, but essential to understand. I’ve just come back from an investment conference in Uruguay, and practically all the presenters made reference to QE. There’s a lot of speculation on what may happen next. Here are my thoughts, and what it means for you.
“Quantitative easing”, or “QE”, when you boil it down, is simply the process of printing money and then lending it to the government at zero interest. It’s just the same as if the central bank printed up fistfuls of notes and then send them over to the finance ministry to be spent on buying votes…er, sorry…I meant on “essential investment”.
…the idea is that this will stimulate the economy by keeping interest costs down. This market manipulation has a knock on effect on all kinds of lending…
But because the cash is routed through the bond markets it creates artificial demand for bonds, which drives up prices and reduces yields. In bankrupt countries that are overloaded with debt (a.k.a. “developed countries”), the idea is that this will stimulate the economy by keeping interest costs down. This market manipulation has a knock on effect on all kinds of lending, from corporate loans, to mortgages, to credit cards.
If that sounds too good to be true as a way to get out of debtors jail, then that’s because it is. As an example, take a look at this chart which I put together using official data. It shows the percentage of UK gilts (the local name for UK government bonds) owned by different types of investors at each quarter end, going back to second quarter 2003 and ending first quarter this year.
Percentage ownership of UK government debt (gilts)
There’s a lot to see in there. But the main thing to look at, is the blue area at the bottom right. This is the percentage of UK government debt owned by the Bank of England as a result of QE purchases.
At the end of the first quarter of this year it was 29% of the total. That’s right, nearly one third of all UK government debt has been funded by direct money printing. In fact total UK government debt is up 125% since the end of 2008, and over half of that has been funded with QE.
And remember, that’s interest free lending to the government. The picture is much the same in the US, where the Federal Reserve also owns nearly a third of US Treasury bonds.
So put yourself in the shoes of one of these money printing governments.
- You are still spending much more than you are receiving in taxes (fiscal deficit), meaning you need to borrow a lot of new money every year.
- Your public debt levels are already high, say 100% of GDP (220% in the case of Japan…even before they’ve funded the 2020 Olympic Games). This means if interest rates go up then you’ll have a much bigger interest cost in future on existing debt that you refinance. Most of your debt matures in the next three years, which means you’ll have the pay the money back to your bondholders. To do this you’ll have to borrow new money at current market rates (bond yields).
- Private corporations have high debt levels, and in fact have been borrowing ever higher amounts in recent years, because debt is cheap due to your policies. Higher interest rates will kill corporate profits.
- Private individuals, also known as “voters”, have huge debts as well. Massive mortgages, credit card balances, car loans, student loans…you name it. If rates go up, so will their interest bills. They will have less left over to spend in the economy on buying stuff. Unemployment would rise. House prices would fall. Voters would get upset, and you’d lose your cosy government job.
- Consumer price inflation is currently quite low, say 2-3%, at least using official statistics. All this money printing hasn’t led to massive price inflation, at least not yet. So what’s the problem if you do a bit more of it?
What would you do in the government’s shoes? I think it’s obvious. You’d keep printing money for as long as you could get away with it. And if you’ve already been kicked out of office by the time things go wrong then you could blame the new government.
But here’s the big question. How long is that period of time?
When will all this money printing result in consumer price inflation? At what public debt level will foreign investors dump your currency, causing a devaluation? What’s the maximum amount of your country’s debt that bond investors will allow your central bank to own before they panic and run for the exits? 40%? 50%? 70?
I don’t know the answers to those questions. I just know we’re likely to find out one day. These policies are transporting us straight to monetary hell.
Back here on earth, there’s a lot of excited talk about so-called “tapering” in the markets. Let’s just remember what this means. It’s the possibility that the US Federal Reserve will buy a bit less debt each month than it has been doing recently. It is not the end of US quantitative easing.
The current rate is $85 billion of purchases a month, or over $1 trillion a year. Tapering means cutting that back to say $80 billion a month, or $75 billion. QE will still continue in a big way, even if the dreaded “taper” happens.
And yet even the hint that tapering might happen has helped to send US bonds into a tailspin. The iShares 20+ year Treasury Bond ETF (NYSE:TLT), which owns US government bonds with average maturity of 28 years, has lost 22% since July last year.
That means yields are up sharply in the bond market (bond yields rise as prices fall, and vice versa). For example yields on US 10 year treasuries, which are a key benchmark rate for all sorts of other debt, have gone from 1.80% to 2.91% in the past year (at time of writing).
So much for US government bonds being “safe” investments!
This kind of sharp rise in benchmark rates has the potential to derail the supposed economic recoveries in developed countries. (Never mind that unemployment rates are still sky high, and the wages of those who have a job are generally much lower than five or six years ago. Especially after inflation is taken into account. Some “recovery”…)
QE in the developed world, across the US, UK, eurozone and Japan. For now it’s just too easy for governments to keep pumping out the money
Faced with this I believe we are likely to see much more QE in the developed world, across the US, UK, eurozone and Japan. For now it’s just too easy for governments to keep pumping out the money, borrowing interest free, and buying votes. Not to mention subsidising their friends in the investment banking industry…
But one day it will all go horribly wrong. History is littered with examples of governments, elected or otherwise, who have destroyed the value of their currencies by increasing the volume too fast. It’s my bet that QE will feature as a past folly when they’re writing the histories of market manias and financial bubbles in 100 years time.
Future investors will shake their heads and wonder how we could have been so stupid as they make a trade with the flick of an eye. Then they’ll go and find their own form of speculative insanity…technology may change but human nature is pretty constant.
In the meantime, what can you do to protect yourself in the next few years? Stay diversified by owning one or more of the following in addition to cash savings: gold, international stocks (shares) bought at the right price, and real estate (physical assets at home or abroad).
When this bubble bursts, when the QE fraud is finally recognised for what it is by the mainstream, you’ll need protection fellow OfWealther. I don’t know when the meltdown will happen, or which country will blow up first. But I do know that it’s worth being prepared.
Until next time OfWealthers,