Best of the Week
Most Popular
1. The Trump Stock Market Trap May Be Triggered - Barry_M_Ferguson
2.Why are Central Banks Buying Gold and Dumping Dollars? - Richard_Mills
3.US China War - Thucydides Trap and gold - Richard_Mills
4.Gold Price Trend Forcast to End September 2019 - Nadeem_Walayat
5.Money Saving Kids Gardening Growing Giant Sunflowers Summer Fun - Anika_Walayat
6.US Dollar Breakdown Begins, Gold Price to Bolt Higher - Jim_Willie_CB
7.INTEL (INTC) Stock Investing to Profit From AI Machine Learning Boom - Nadeem_Walayat
8.Will Google AI Kill Us? Man vs Machine Intelligence - N_Walayat
9.US Prepares for Currency War with China - Richard_Mills
10.Gold Price Epochal Breakout Will Not Be Negated by a Correction - Clive Maund
Last 7 days
The Hottest Sports Stock Of 2020 - 23rd Sep 19
Stocks Wedge At The Edge – Front And Center - 23rd Sep 19
Stock Market Top Almost Confirmed - 23rd Sep 19
Thomas Cook COLLAPSE! 300,000 Passengers Stranded, Flights Cancelled, Planes Grounded - 23rd Sep 19
Massive Stock Market Price Reversion May Be Days or Weeks Away - 22nd Sep 19
How Russia Seized Control of the Uranium Market - 22nd Sep 19
Dow Stock Market Trend Forecast Update - 21st Sep 19
Is Stock Market Price Revaluation Event About To Happen? - 21st Sep 19
Gold Leads, Will the Rest Follow? - 21st Sep 19
Are Cowboys Really Dreaming of... Electric Trucks? - 21st Sep 19
Gold among Negative-Yielding Bonds - 20th Sep 19
Panicky Fed Flooding Overnight Markets with Cash - 20th Sep 19
Uber Stock Price Will Crash on November 6 - 20th Sep 19
Semiconductor Stocks Sector Market & Economic Leader - 20th Sep 19
Learning Artificial Intelligence - What is a Neural Network? - 20th Sep 19
Precious Metals Setting Up Another Momentum Base/Bottom - 20th Sep 19
Small Marketing Budget? No Problem! - 20th Sep 19
The Many Forex Trading Opportunities the Fed Day Has Dealt Us - 19th Sep 19
Fed Cuts Interest Rates and Gold Drops. Again - 19th Sep 19
Silver Still Cheap Relative to Gold, Trend Forecast Update Video - 19th Sep 19
Baby Boomers Are the Worst Investors in the World - 19th Sep 19
Your $1,229 FREE Tticket to Elliott Market Analysis & Trading Set-ups - 19th Sep 19
Is The Stock Market Other Shoe About To Drop With Fed News? - 19th Sep 19
Bitcoin Price 2019 Trend Current State - 18th Sep 19
No More Realtors… These Start-ups Will Buy Your House in Less than 20 Days - 18th Sep 19
Gold Bugs And Manipulation Theorists Unite – Another “Manipulation” Indictment - 18th Sep 19
Central Bankers' Desperate Grab for Power - 18th Sep 19
Oil Shock! Will War Drums, Inflation Fears Ignite Gold and Silver Markets? - 18th Sep 19
Importance Of Internal Rate Of Return For A Business - 18th Sep 19
Gold Bull Market Ultimate Upside Target - 17th Sep 19
Gold Spikes on the Saudi Oil Attacks: Can It Last? - 17th Sep 19
Stock Market VIX To Begin A New Uptrend and What it Means - 17th Sep 19
Philippines, China and US: Joint Exploration Vs Rearmament and Nuclear Weapons - 17th Sep 19
What Are The Real Upside Targets For Crude Oil Price Post Drone Attack? - 17th Sep 19
Curse of Technology Weapons - 17th Sep 19
Media Hypes Recession Whilst Trump Proposes a Tax on Savings - 17th Sep 19
Understanding Ways To Stretch Your Investments Further - 17th Sep 19
Trading Natural Gas As The Season Changes - 16th Sep 19
Cameco Crash, Uranium Sector Won’t Catch a break - 16th Sep 19
These Indicators Point to an Early 2020 Economic Downturn - 16th Sep 19
Gold When Global Insanity Prevails - 16th Sep 19
Stock Market Looking Toppy - 16th Sep 19
Is the Stocks Bull Market Nearing an End? - 16th Sep 19
US Stock Market Indexes Continue to Rally Within A Defined Range - 16th Sep 19
What If Gold Is NOT In A New Bull Market? - 16th Sep 19
A History Lesson For Pundits Who Don’t Believe Stocks Are Overvalued - 16th Sep 19
The Disconnect Between Millennials and Real Estate - 16th Sep 19
Tech Giants Will Crash in the Next Stock Market Downturn - 15th Sep 19
Will Draghi’s Swan Song Revive the Eurozone? And Gold? - 15th Sep 19
The Race to Depreciate Fiat Currencies Is Accelerating - 15th Sep 19
Can Crypto casino beat Hybrid casino - 15th Sep 19
British Pound GBP vs Brexit Chaos Timeline - 14th Sep 19
Recession 2020 Forecast : The New Risks & New Profits Of A Grand Experiment - 14th Sep 19
War Gaming the US-China Trade War - 14th Sep 19
Buying a Budgie, Parakeet for the First Time from a Pet Shop - Jollyes UK - 14th Sep 19
Crude Oil Price Setting Up For A Downside Price Rotation - 13th Sep 19
A “Looming” Recession Is a Gold Golden Opportunity - 13th Sep 19
Is 2019 Similar to 2007? What Does It Mean For Gold? - 13th Sep 19
How Did the Philippines Establish Itself as a World Leader in Call Centre Outsourcing? - 13th Sep 19
UK General Election Forecast 2019 - Betting Market Odds - 13th Sep 19
Energy Sector Reaches Key Low Point – Start Looking For The Next Move - 13th Sep 19
Weakening Shale Productivity "VERY Bullish" For Oil Prices - 13th Sep 19
Stock Market Dow to 38,000 by 2022 - 13th Sep 19 - readtheticker
Gold under NIRP? | Negative Interest Rates vs Bullion - 12th Sep 19
Land Rover Discovery Sport Brake Pads and Discs's Replace, Dealer Check and Cost - 12th Sep 19
Stock Market Crash Black Swan Event Set Up Sept 12th? - 12th Sep 19
Increased Pension Liabilities During the Coming Stock Market Crash - 12th Sep 19
Gold at Support: the Upcoming Move - 12th Sep 19
Precious Metals, US Dollar, Stocks – How It All Relates – Part II - 12th Sep 19

Market Oracle FREE Newsletter

How to Invest in the Esports Revolution

How to Legally Manipulate Interest Rates

Interest-Rates / Market Manipulation Mar 18, 2018 - 05:22 PM GMT

By: Science_Investing

Interest-Rates

Rationale Behind Quantitative Easing

The Fed embarked on asset purchases, which they call quantitative easing or QE, during the global financial crisis 2007-2008. The move was motivated by a complete loss of confidence in the financial system. As a result, investors and financial institutions feared losses due to large scale bankruptcies. Liquidity dried up completely and money was hoarded in allegedly safe places. The Fed stepped in with various measures and effectively returned confidence to markets. Quantitative Easing was among these whilst it was applied for the first time in US monetary history. 


The determined intervention probably contributed to prevent a larger crisis. At that time people feared another great depression. It may have been forgotten today but the first chart below shows the google search term “economic depression”. Countercyclical policy and confidence building is enormously important in such situations.

Bildschirmfoto%202018-03-15%20um%2015.15.41.png   

Market Intervention Dominates Interest Rates

The Quantitative Easing program was extended after the crisis in order to stimulate the economy. The Fed continued to buy assets like corporate bonds and mortgage backed securities. As a consequence, interest yields decreased to historically low levels.  

Eventually animal spirits returned back to the markets and the money that was parked in safe haven assets searched for reinvestment opportunities. Obviously low interest rates across the board channeled capital into other assets. That is a side effect of market intervention. Especially equity investments prospered during the past 10 years. Liquidity was attracted first by attractive valuation and dividend yields and later by market momentum. Corporate America found it also easy to borrow money. Luckily, the market could count on the Fed to find a reliable buyer. Hence, a large scale reallocation of liquidity took place due to monetary policy.  

Inflationary Effects of Quantitative Easing

Quantitative easing isn't automatically inflationary despite popular belief. It can be viewed as a Keynesian instrument for countercyclical policy (flattening economic business cycles). Asset purchases made during an economic contraction can be unwound during the subsequent economic expansion. Interest rates can be controlled through this mechanism. During expansions liquidity can be taken out of the system again and interest rates get pushed to the upside. 

The mechanism can be better understood with an example: Central bank bond purchases puts liquidity in the hand of the seller. This liquidity is typically stored in bank accounts. It only becomes inflationary once the bank lends it to someone. The money needs to get back into the economy in order to multiply. Hence, liquidity from QE purchases that ends up in a bank account does not fulfill this requirement and is therefore not inflationary. The bank must be willing to lend the money and someone must be willing to borrow the money, which resulted from QE. This is often difficult in practice.

Most people tend to be rather pessimistic and cautious during economic downturns. They fear loosing their job for example. Borrowing in such situations to upgrade to a new car is subdued in such cases. This is regardless if the bank offers a 1% or 5% interest rate. You will not upgrade to a new car if you fear that your job is not safe short term! Banks are also often reluctant to lend during economic downturns. Decision process are directed by people who tend to be more pessimistic about potential outcomes during economic downturns relatively to expansionary periods. You may have already encountered the situation: “10 years ago it was easy to get funding for project xyz but now banks are much tougher”. Animal spirits are at work there – a term used by John M. Keynes to describe risk inclination of human behavior.

Central banks can monitor how much is lent out and step into the market eventually. Assets can be sold from the balance sheet once the business cycle turns.

The theoretical outcome of QE results into a socialization of the debt burden. Central bank exposure implies that the outcome, positive or negative, will be passed on to the tax payer. It also means that an economy can kick its debt burden longer down the road. The deleveraging process of an economy gets extended as QE resembles a new instrument that entered central bank balance sheets on a large scale just recently.

Quantitative Easing in Practice

The theory behind quantitative easing is great. It is a modern instrument to steer monetary policy. However, practice does not always run 100% according to plan in our complex world. We witnessed for the first time that central banks embarked upon such a policy. There is no track record with sufficiently measurable results yet. Japan has been the first economic experiment involving QE. It started in the early 2000’s. The BoJ intended to fight deflation by bringing more liquidity into the system. We have witnessed this experiment now for more that one and a half decades in Japan and still do not record significant inflation there. Seeing no inflation in Japan due to QE is actually what should rather worry central bankers applying this instrument. It implies that the measure is either ineffective or uncontrollable. Therefore, the same probably applies to economic expansions. The financial system will have an extended monetary base that is either ineffective or uncontrollable.

Higher Inflation Eventually Likely

Western economies have reached historically high levels of leverage. Further debt driven growth seems less likely than a deleveraging process in the near future. Growth has been subdued in comparable situations historically. The best results (least painful) occurred in periods of moderate inflation. It should be therefore quite tempting for policymakers to target an inflation rate of 4-5% along economic growth. This figure effectively halves the total debt burden during a 10-year period.

The problem is that the complexity of the real world makes it harder to achieve this target. Moreover, there are natural conflicts of interest between politicians who get elected for 4-5 year terms and long-term economic goals. Keynesian policy making has not been properly applied in recent history. The US economy went with a sizable Debt/GDP position into the global financial crisis 2007-2008. A long economic expansion preceded this financial crisis. Diligent Keynesian politics would have resulted in a very strong financial position of the Government going into that crisis. Obviously no politician wants to take the foot off the gas pedal and rather individualize economic success to their own account.

Similarly, central banks around the world expanded their mandate. Today, they are more powerful than ever before. Not only central bank balance sheets increased but also borders of what is acceptable and what not get shifted. The BoJ and SNB have, for example, bought risky assets such as equities. At the same time, they still do not have precise forecasting instruments to assess the exact stage of an economic cycle. Nor do they have a reliable assessment regarding the correct quantity of their policy instrument. Last but not least, no reliable research has been published regarding risk inclination and aversion cycles as of today.

Hence, the US faces an economy with a high debt level and some moderate inflation is the best way out. Central banks have a terrible track record in identifying asset bubbles as well as cycle turns. This makes inflation likely as soon as animal spirits return into the economy. It will probably overshoot the preferred targets of policymakers.

Rising Inequality & Other Effects of Quantitative Easing

Low interest rates lead to a reallocation of capital. Dividend yields, and rental yields become more attractive on a relative basis. It should be no surprise that QE has led to a bull market in equities and stopped the correction in the housing market. It does mostly affect the top 1% as their wealth predominately consists of equity and real estate. QE resulted in inflationary asset prices. It was concentrated in economic sectors that saw expansion or particular interest from the top 1%. Housing prices in economic prosperous areas such as New York,  London, San Francisco and Silicone Valley reached elevated levels and even created bubbles in some areas. The past years brought a positive correlation between exclusivity and inflation. New York properties listed for $ 100,- million are most likely the result of that.

At the same time, it is more than questionable weather QE produced measurable positive outcomes for the bottom 50% of the economy post 2013. This leads to rising inequality. IMF economists show facts in this blog why inequality threatens sustainable economic growth and development. Their conclusion is that extreme inequality in the US makes major economic problems even worse.

Conclusion

QE is a valuable policy if implemented properly. It has most likely contributed to the end of the global financial crisis 2007-2008. The interest rate market remained dominated by central bank intervention until today. Unwanted side effects to QE are visible already. Higher inflation will most likely follow eventually. This will be probably visible during the next economic expansion.

About The Author
Our background lies in economics and trading. We have been trained at reputable universities and worked as proprietary traders as well as portfolio managers throughout the past couple of decades. We started exploring the field of behavioral economics due to self-interest in the late 90’s.

Our goal is to contribute outstanding technical analysis and forecasting. We focus on the most liquid assets that are subject to worldwide public attention.

Please visit us for more information:

http://www.scienceinvesting.com/

© 2018 Science Investing - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules