I have recently made the case that the rise in financial asset prices has increasingly decoupled from the weakening fundamentals of the real economy and that the predictable spigot of central bank liquidity has encouraged excessive risk taking (and has contributed to too high valuations), raising corporate incentives to over borrow and over engineer.
Stated simply, the steady and relentless climb in stock prices has caused me to question how long and how far deteriorating fundamentals and historically high valuations can coexist.
Slowing Data as the Impact of QE Diminishes
There is now evidence of a clean sweep of the data in terms of the limiting effect (and diminishing return) of QE on real global economies:
* As far as the Eurozone is concerned, five years of negative nominal interest rates and a renewed €20 billion ($22 billion) monthly asset purchase program has yielded nothing in the way of tangible results. Eurozone economic and inflation data remain moribund, as fourth quarter GDP grew 0.9% from a year ago, its weakest since 2013, while CPI inflation has averaged just 1.2% year-over-year in the last 12 months.
* As noted yesterday, Japanese GDP has been a source of continued disappointment.
* Low rates have gutted the Japanese and European banking industry. Japanese banks are -90% from highs and the Euro bank index is trading below its 2009 level.
My strong view is QE and QE plus (negative rates, central banks buying equities) have been counterproductive, for a number of reasons - including the reason that its numbing effect takes pressure off politicians to make structural change. Though I cannot prove I am right, central bankers who believe QE and QE plus have been helpful, also cannot prove they are right. But the evidence favors me more than them. In fact there is no real world data that shows QE has helped, only hypothetical self-justifying analysis from the same Central Bankers whose programs resulted in missed GDP forecast after missed GDP forecast:
* Every major economy that has embarked on QE or QE plus (negative rates, central banks buying equities) including the U.S. has MISSED the forecasts that were put in place for the improvement those initiatives were meant to garner
* The only economy that saw any bump while this stuff was going on was the U.S., and just recently, only AFTER the last batch of QE ended and prior to the recent batch of QE started. That bump was due to a set of very different economic and structural policies that were put in place with a new administration. In fact the economic bump to the real underlying economy happened as liquidity was being withdrawn and rates were being increased. Goes back to my point yesterday that fiscal and structural policy is really where the focus should be, and central bankers should show more discipline with regard to trying to plug holes the other side of the house should be addressing. I am not trying to make any arguments as to whether the new policy set is good or bad, just stating the obvious that there was a change, and it has created a short term bump at a minimum.
* Not one country where QE was implemented has made any real structural reform, with the exception of the U.S. per above point, due to a radically different administration. Maybe if Japan and Europe didn't put all their eggs in the financial engineering basket and focused more on structural reform, their economies would be better off.
* In every country where QE was implemented, including the U.S., since these programs were implemented, measures of societal well being have plummeted. GDP does not proxy everything. It does not tell you how people feel. Across the U.S. and Europe, social/political tension is through the roof. A fair portion of that is due to the hyper wealth gap that has emerged, and QE has a lot to do with this. For all intents and purposes the rich (with large balance sheets) got richer from asset appreciation, the super rich got so much super richer that it even pissed off the normal rich, and the poor made little to no progress.
(1) If a side effect of QE is that due to push back against the super wealthy, investors must ask that if Senator Bernie Sanders becomes president, how will Democratic Socialism make the U.S. better off?
(2) Would the Central Bankers then put MMT (modern monetary theory) in place to fund giveaways of everything, which would for all intents and purposes make everyone equally poor as it is toxic central banking policy on top of toxic economic policy?
In the face of all of this, any admission from Central Bankers that maybe they have been wrong and misguided? Nope. Their view is we just need to do more.
As an example, Janet Yellin was out yesterday with this little nugget (hey Janet you been paying attention to Japan and Europe???) - h/t Zerohedge:
"It could be useful to be able to intervene directly in assets where the prices have a more direct link to spending decisions," she said, adding that buying equities and corporate bonds could have costs and benefits. Keep in mind that what Yellen said was merely a paraphrase of Ben Bernanke's famous April 2010 WaPo oped in which he defended easy monetary policy is facilitating higher stock prices, which would "boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion."Of course, none of this "trickle-down" ever happened, and instead what did happen is that the top 10% of US society who own 93% of all equities got fantastically rich...while the bottom 90% who own virtually no stocks and owe most of the debt, got very, very angry as they watched how the Fed plundered their future and hopes to become wealthy, and resulted first in the election of Trump, and the upcoming election of a socialist candidate as America goes full-on populist in response to the Fed's catastrophic policies."
This is all absurd. Although I am not in favor of what I am about to recommend, if it comes to this rather than relying on very blunt and very indirect transmission mechanism that seems to disproportionately benefit the wealthy, wouldn't it just be easier and more direct to send money directly to those most in need? Ergo the poor and not the rich? Or a payroll tax reduction or other things of that nature?
And if the politicians fail at this stuff, in come the central bankers right away, and the politicians never do what they should do. And at the end of the day we are worse off for it.
I wish there was a Supreme Court for Central Bankers.
When the U.S. Fed and Fed Mandate was put in place, something tells me it was never the intent of the founders of the mandate that it would be taken this far. By the same token, if Central Bankers lived in the real world where performance is measured against plan, they would have all been fired long ago. These guys get to fail, and just do more. Quite the job description!
That said, there is one aspect of QE I am comfortable with. That is the portion of QE1 that was specific only to the bailout of the U.S. financial system. Fed balance sheet shenanigans beyond that, not good.
The lender of last resort role of the Federal Reserve is an important one. There are many bright people that argue that should be the only role of the Fed. Rates and everything else can be handled by free markets. Some bright people even argue the Fed should not have bailed out the financial system (certain large banks) and let the system fend for itself. They may be right, but in my view that is a bet you cannot afford to take, because if you get it wrong, the consequences could be dreadful. The mere act of only serving as a lender of last resort alone, and then stopping there, I think does not have much in the way of adverse consequences. Sure there are some (like people in banks continuing to believe they can lend with no regard to risk), but there are other careful regulatory ways of dealing with that issue.
Yesterday I also referenced the notion that fiscal and structural policy are more effective at dealing with many of the problems modern economies are facing. What I neglected to mention is that capitalism itself was always an effective way of dealing with these issues. Cycles, while painful in the downcycle, really do cleanse the system. The U.S. became the best and most powerful economy in the history of the world while going through periods of sharp downcycles.
With QE, there are no longer cycles. Interest rate suppression is a powerful numbing agent. I am not sure why the Federal Reserve believes it is important to remove cycles from the economy. There seems to be a pathological focus on never having a recession. By definition, that is no longer capitalism. I am not sure what it is, but it seems to have elements of a planned economy and is as close to communism as it is capitalism. I know Central Bankers have models that suggest GDP and trendline employment is better when there are no cycles (their models suggest strong upcycle does not make up for downcycle), but all the actual data shows otherwise. QE seems to certainly reduce volatility, but the data shows trendline growth has also been halved in recent years, and GDP is not too far from zero in the economies that have implemented QE and QE plus absent structural change. All sorts of excuses for this, secular stagnation, etc. How about every major economy has embarked on QE, prevented recessions, taken volatility out of the system, but at the expense of sharp recoveries and healthy growth, like we used to have!
And Back to Reality and the Bottom Line
Speaking of the numbing effect on volatility, there is a major virus outbreak the likes of which has not been seen in our lifetimes, volatility sits near lows, and financial markets are at highs.
We have a numb economy. That is what QE gets you. And that is the best case assuming nothing eventually blows up due to all the imbalances that are created in the process or the wealth disparity that has emerged does not cause massive social upheaval.
All problems cannot be solved with monetary policy. When you try to do that, there are real negative and unintended and unknown consequences. Most of the change needs to come from governments themselves (elected officials as opposed to unelected ones) and from the natural mechanism of capitalism itself.
(This commentary originally appeared on Real Money Pro on February 20. Click here to learn about this dynamic market information service for active traders and to receive Doug Kass's Daily Diary and columns from Paul Price, Bret Jensen and others.)