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Usually, when a government starts financing itself with the printing press,
it finds it mightily difficult to stop, even if there is some will to do so.
The notion that the Fed will continue with QE forever is not tenable, on an
intellectual basis; thus, it must stop. With asset markets getting rather
bubbly from a valuation perspective (particularly credit markets), Ben
Bernanke suggested that the Fed would indeed reduce its bond-buying, and
perhaps cease it altogether sometime in mid-2014.
This caused a pullback in equities. But, much more importantly, it caused a
mini-crash in U.S. Treasury bond prices, which rose about 100bps from bottom
to top in May and June. This alone, due to the leveraged nature of bank
balance sheets, the mountains of derivatives (especially interest rate swaps)
based on Treasury yields, and the use of Treasury bonds as collateral for all
sorts of lending, may have led to substantial destabilization of several
major banks in June.
At the same time, mortgage rates made an even larger jump higher, brushing
the 5.0% level for 30-year fixed mortgages. This shuts down any advantage
from refinancing, makes home purchases substantially more difficult, and also
makes present valuations in many markets once again rather suspect.
Simply suggesting the possible end of QE � an idea rather tame in itself �
caused the conditions that justified further continuation of QE.
For now, Wall Street is probably pretty happy with that. The first reaction
toward the suggestion of a �taper delay,� in other words, more QE for longer,
will probably be some recovery in both stock and bond prices.
The U.S. economy has been on a gentle slope of deterioration, which may
accelerate if asset markets stumble and mortgage rates remain at relatively
elevated levels.
Elsewhere, both Europe and Japan are becoming increasingly troublesome.
Sovereign bond yields in Europe, which cooled off last autumn, have been
rising back toward crisis levels � no surprise, since the last nine months
have proven that nothing in Spain, Italy, and elsewhere is getting any
better. China, for a while a bulwark of stability, may have begun a hot
crisis in the financial sphere. Places like Brazil and Turkey are seething
with civil unrest.
In Britain, a new Bank of England governor promises more �easy money� � yes,
a reignition of QE there too � to solve difficult
problems. Japan�s latest QE is turbo-printing mania, at a pace (relative to
GDP) three times as large as the Fed�s present program. With the JGB market
persistently unsettled, the prospects of Japan backing off its QE agenda are
also less likely, as that might precipitate a bond crash there that would
make the recent rise in Treasury yields look like a speedbump.
The ECB might be pressed into making good on its promise to buy up troubled
sovereign debt if necessary. It�s looking more necessary.
�Austerity� in Europe has been largely abandoned, and the United States will
not likely trouble itself much more with such things either. Politically, the
drift is back towards �stimulus,� though leaning more toward the monetary
sort as governments� borrowing capacities have been depleted worldwide.
In other words, the rest of the world is not only drifting toward more (not
less) QE itself, but the implications of all of this for the U.S. is also �
more problems, and thus more QE for longer.
One of the problems with Keynesianism in general is �the ratchet.� The
government spends a lot of money to supposedly get the economy going. This is
inevitably disappointing, but enough effects are felt � and enough money was
spread among the political cronies � that the program seems justified. Now,
the government must not only maintain its pace of spending, but increase it,
lest it supposedly suffer a �fiscal contraction.�
We are beginning to see the QE ratchet. The U.S. economy is disappointing,
but enough benefits have seemed apparent from very low interest rates that
allowing rates to rise back to what are actually still very low levels seems
unacceptable.
Remember the �exit strategy�? It was a topic of discussion in 2010. The idea
that the Fed could continue what it had been doing for a long period of time
seemed intellectually untenable then too. Three years later, not only has
there been no exit, but the Fed is in deeper than ever.
We will have continuous talk of the �taper,� �exit,� or whatever new buzzword
is brought out when the old ones become noticeably worn. The notion that the
Fed could just keep going will continue to seem implausible, even as that is
what actually happens. A hot crisis in banks, perhaps later this year, might
even turn the �taper� into the �ramp� as the QE spigots open wider.
The first reaction would probably be giddy enthusiasm, just as it was earlier
this year in Japan when their QE afterburners kicked in and slammed everyone
back into their seats with smiles on their faces.
Perhaps it will not work out that way. I could be wrong. But, that is what
has happened to many governments in the past, and today seems to me no
exception.
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