Quantitative Easing means printing more money

Investor Fundamentals: What Is Quantitative Easing?

So let's stick with the simple one.

Alternative to negative interest

The relaxation (expansion) of the money supply is part of the normal business of a central bank, as is the tightening (reduction) of the money supply. These are key functions a central bank uses to keep the economy stable: not too hot, not too cold, low inflation, high employment, good mood in the stock markets, happy homeowners, etc.

The most important instrument a central bank can use to manage the economy is its own interest rate. The interest rate will be lowered to ease it and it will be increased to tighten it. The second most important instrument of a central bank is bond trading. Bonds are bought to relax and sold to tighten. The problem with this is that interest rates cannot go down indefinitely. So when interest rates are already very low and the economy collapses - as in 2008 - the only option for further easing is to buy bonds, not with a targeted interest rate, but in fixed amounts. Hence the attribute «quantitative». In the words of Jonathan Wilmot, strategist at Credit Suisse, the simple definition is: “Quantitative easing is the monetary easing measure that central banks take when they want to cut interest rates to -3 percent but realize they are can only go down to zero. "

Got a trillion?

The fixed amounts, however, are gigantic. Since 2008, the central banks have created several trillion dollars, euros, yen, pounds and kroner with quantitative easing that would otherwise not exist. If they hadn't, Wilmot continued, we would now be stuck in a global depression. In the first round from 2008 to 2010, today known as “QE1”, the US Federal Reserve prevented “a series of bankruptcies, a massive debt spiral and a general collapse of the economy as we know it”. Otherwise the same thing would have happened as in the 1930s and 1890s. Later QE rounds in America, Japan, Great Britain, the euro zone and Sweden were probably not quite as existential. Still, Wilmot and many other experts believe that quantitative easing was a good thing overall, and kept people in their jobs and kept the economy from collapsing.

Quantitative Easing Bubble Formation?

Too much of a good thing, as some economists find. Anna Zabrodzka from Moody's Analytics, for example, argued in a comment from mid-July 2015: "Quantitative easing promotes asset bubbles." House prices in Germany, Norway and Great Britain in particular have been inflated by the quantitative easing of the European Central Bank. David Stockman, the former head of the US budgetary authority, goes even further than Zabrodzka and describes quantitative easing as "wrongly priced" fraud. His difficult definition is: “The massive monetization of public debt leads to the systematic repression of the 'cap rate' with which the entire financial system functions. And if the cap rate is artificially pushed to an uneconomical level ... »Well, to put it more simply: quantitative easing leads to bubbles. But Wilmot argues that this interpretation confuses correlation and causality. In fact, bubbles could form, and quantitative easing is a fact, of course, but that doesn't mean one caused the other.

Rise of the “Parity Risk” portfolios

Unfortunately, quantitative easing also has side effects, adds Wilmot. This includes, for example, that it has favored a portfolio management approach known as “risk parity”. Jennifer Bollen formulated a simple definition for this in “Investment & Pensions Europe”. Risk Parity, she writes, works with leverage, not to increase returns, but to reduce risk. This takes place within a broad portfolio that includes stocks, bonds of various types, securitized mortgages, commodities, and real estate. Wilmot points out that risk-parity investors and a related strategy called “Volatility Controlled Equity” could have triggered the turbulence that shook the stock markets from mid-August to mid-September 2015. Risk-parity investors were forced to reduce debt, that is, sell their investments, causing stock prices to plummet, with the global MSCI ACWI index dropping 7 percent. Ironically, the strategy of reducing risk for a few leads to increased risk when many do so.

Future generations are losers

It is easy to define who has to pay the most for quantitative easing. Many voices - from the International Monetary Fund to the European Central Bank (ECB) to the OECD, the think tank of industrialized countries - have warned that the easing policy and easy money pose a threat to pension funds and insurers. Indeed, they should be concerned, but their future customers have even more to worry about. Take the case of a British person shortly before retirement who has paid into a “defined contribution” pension (as opposed to a pension based on the salary before retirement). If he goes the usual way and converts his retirement capital into a fixed pension, he will at best receive around a third of the return that would have been paid out on the same amount 25 to 30 years ago. Thanks to the easy money from quantitative easing (and record low interest rates), the sad truth is that many near-retirement seniors will be forced to work longer and live more modestly than planned, even if they have calculated carefully.

Quantitative Easing - How Much Longer?

The US program has already expired and, while the ECB program is still running, the prevailing view is that quantitative easing will be phased out over the course of the coming year. That does not mean, however, that central banks will have fully recovered from the shock of 2008 and its aftermath by then. According to Wilmot, it will take longer before frightened banks and markets find their animal spirits again. These were defined by the economist John Maynard Keynes, who wrote in 1936: “Probably most decisions to do something positive […] can only be traced back to spirits - to a sudden impulse to act rather than inactivity, and not to the weighted average quantitative advantages, multiplied by quantitative probabilities. " If that definition is too difficult, we can put it this way: fear and greed, or caution and confidence, drive the markets. Wilmot anticipates the U.S. will move ahead with a slow recovery of confidence in due course, with rates likely to climb to 3-4 percent by 2018.