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Richard Mellor

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Global Economy: The end of QE
« on: September 22, 2017, 06:01:04 AM »
Global Economy: The end of QE

by Michael Roberts

It?s an historic day in global central bank monetary policy since  the end of the Great Recession.  The US Federal Reserve Bank feels  sufficiently confident about the state of the US economy and, for that  matter the rest of the major economies, to announce that it has not only  ended quantitative easing (QE)  but that it is now going to reverse the  process into quantitative tightening.

QE was the policy of pumping money (by creating bank reserves) into  the financial sector by buying government and corporate bonds (and even  shares) in order to create enough cash in the banks to lend onto  households and companies and keep interest rates (the cost of borrowing)  to near zero (or even below in some countries).  QE was the key  monetary policy of the financial authorities in the major economies,  particularly in the light of little fiscal or government spending as a  second or alternative weapon.  Fiscal austerity was applied (with  varying degrees of success) while monetary policy was ?eased?.

But QE was really a failure.  It did not lead to a revival of  economic growth or business investment.  Growth of GDP per head and  investment in the major economies continue to languish well below  pre-crisis rates.  As I have argued in this blog, that is because profitability in capitalist sector remains below pre-crisis levels and well below the peaks of the late 1990s.

What QE did do was fuel a new speculative bubble in financial assets,  with stock and bond markets hitting ever new heights.  As a result, the  very rich who own most of these assets became much richer (and inequality of income and wealth has risen even further).  And the very large companies, the FANG (Facebook, Amazon, Netflix and Google) in the US, became flush with cash and doubled-up on borrowing even more at near zero rates so that they  could buy up their own shares and drive up the stock price, hand out big  dividends to shareholders and use funds to buy up even more companies.

But now eight years after QE was launched in the US, followed by the  Bank of Japan, the Bank of England and eventually the European Central  Bank, the US Fed is preparing to reverse the policy.  It has announced  that it will start selling off its huge stock of bonds ($4.5trn or 25%  of US GDP at the last count) over the next few years.  The sell-off will  be gradual and the Fed is cautious about the impact on the financial sector and the wider economy.  And it should be.

Financial markets won?t like it.  The drug of cheap (virtually  interest-free) money is being slowly withdrawn.  The plan is to avoid  ?cold turkey?, but even so the stock and bond markets are likely to sell  off as the supply of free money begins to fall back.  More important is  what will happen to the productive sectors of the US economy and, for  that matter, to the global economy, as this cheap money slowly declines.

The Fed sounds confident.  As Janet Yellen, the head of the Fed put it in the press conference yesterday: ?The  basic message here is US economic performance has been good; the labour  market has strengthened substantially.  The American people should feel  the steps we have taken to normalise monetary policy are ones we feel  are well justified given the very substantial progress we have seen in  the economy.?

This confidence is being increasingly backed up by the mainstream economic forecasters. 
For example, Gavyn Davies, former chief economist at Goldman Sachs and now columnist at the FT, reports that his Fulcrum ?nowcast? activity measures reveals the ?growth  rate in the world economy is being maintained at the firmest rate  recorded since the early days of the recovery in 2010. The growth rate  throughout 2017 has been well above trend for both the advanced and  emerging economies, and the acceleration has been more synchronised  among the major blocs than at any time since before the Great Financial  Crash.?  He has the advanced economies growing at 2.7% and the  world economy at 4.1%, with the US growth rate now around 3%.  This all  sounds good.

And yet the long-term forecasts of the Fed policy makers for economic  growth and inflation remain low.  Indeed, there are some important  caveats to this seeming confidence.  First, there is little sign of any  recovery in business investment.

Second, far from profits in the productive sectors racing ahead, overall non-financial corporate profits in the US are falling.

And equally important, as the recent Bank for International Settlements quarterly review has highlighted, corporate debt is very high and rising, while the  number of ?zombie? companies (those hardly able to meet their debt  payments) are at record levels (16% in the US).  At $8.6 trillion, US  corporate debt levels are 30% higher today than at their prior peak in  September 2008.  At  45.3%, the ratio of corporate debt to GDP is at historic highs, having  recently surpassed levels preceding the last two recessions.  That suggests that increased costs of debt servicing from rising interest rates driven by the Fed?s ?normalisation? policy could tip things over, unless profitability recovers for the wider corporate sector.


As the BIS summed it up, ?Even accounting for the large cash  balances outstanding, leverage conditions in the United States are the  highest since the beginning of the millennium and similar to those of  the early 1990s, when corporate debt ratios reflected the legacy of the  leveraged buyout boom of the late 1980s.  Taken together, this suggests  that, in the event of a slowdown or an upward adjustment in interest  rates, high debt service payments and default risk could pose challenges  to corporates, and thereby create headwinds for GDP growth.?

And this is just at a time when the US Fed has decided to hike its  short-term policy interest rate and cut back on the lifeline of cheap  money to the banks.  As I have pointed out before, during the Great Depression of the 1930s, the Fed did something similar in 1937,  reversing its policy of cheap credit when it thought the depression was  over.  That led to a new slump in production in 1938 that only the  second world war ended.  The risk of repeat remains.
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