By GRAHAM FROST 03/11/2010
Today the US Federal reserve expanded its quantitative easing (QE) by $600billion. This is in addition to the $1.7trillion of asset purchases made during the credit crunch. It is designed to push down long term interest rates and boost assets prices. Why does the US need to do this and will it work?
America’s growth rate has not responded much to the massive fiscal and monetary stimulus already undertaken. The economy is barely creating enough jobs to employ new entrants to the labour pool and unemployment remains at 9.6%. When interest rates are close to zero, a central bank can’t do much else to stimulate activity, or avoid deflation, other than print money. The money is used to buy treasuries mainly from banks who then have cash they can lend out or invest in riskier assets. That of course assumes that banks want to lend and that consumers want to borrow. Currently, and for the foreseeable future, we would suggest that both banks and consumers will want to reduce debt and build up savings. Consumer debt is still double the level of 1960-80s, and is only sustainable due to extraordinarily low interest rates.
It is by no means certain that deflation is around the corner either. Although core consumer inflation is below 1%, the massive increase in commodity prices over the last year will surely feed into prices eventually. Although a slide back into recession would probably suppress prices further, so far the recovery has been similar to past recoveries from recession. So, printing money could be a risky gamble and let the inflation genie out of the bottle.
QE leads to a weaker currency since printing money dilutes the existing money stock. A weaker currency helps exporters. Unfortunately, everyone would like to do that so this policy can result in competitive devaluations. That’s already happening with Japan lining up its own QE to respond to whatever the Fed does.
Some may say that it was Greenspan’s easy money policy that created the asset bubbles and borrowing binge for which we are now paying. And that Bernanke is merely repeating the error. It is difficult to say how much of the coming QE has been discounted in market prices. Quite a bit I would think.
Where should investors be putting their money?
Printing more money will weaken the US dollar and drives the up the price up of dollar based assets like commodities such as oil and gold. Recommendation: First State Global Resources
The Fed have signalled their intent and stock markets have welcomed the news, however the Fed will be buying bonds not shares, which are dependent on the US economy recovering. Nothing is certain though, so investors should remain diversified and longer term look to increase allocation to regions of economic growth, such as Asia. Recommendation: Aberdeen Asia Pacific.