Mumbai: It’s time to stop talking about QE1, QE2, QE3 and so on. Instead, we should just call it unlimited QE (quantitative easing). Here are two quotes from Helicopter Ben that give the game away: “If the outlook for the labour market does not improve substantially, the committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.” In other words, like European Central Bank (ECB) boss Mario Draghi, he’ll do what it takes. And here’s the icing Ben Bernanke put on the cake: “To support continued progress toward maximum employment and price stability, the committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.”
Across the Atlantic, Super Mario is doing exactly the same thing. ECB’s unlimited bond-buying programme has already sparked off a big rally in risk assets. In China, too, the government is loosening its purse strings. And do we have a precedent of this unlimited QE world? Of course, we have—look at Japan.
One other point needs to be underscored. This time the QE tonic has been administered at a time when stock markets have been rallying. More importantly, this time the Dow Industrials are at a five-year high. So it’s no longer a matter of merely combating market weakness—the signal Bernanke is giving out is he would like to see the market go up even further, so that the “wealth effect” helps the economy recover.
Markets in recent times have been moving in a curious fashion, completely ignoring bad news about the economy as they look forward to monetary stimulus. They don’t seem to bother that global manufacturing production has contracted for the last three months, according to the Purchasing Managers’ Index data. With the promise of unlimited monetary easing by the US Federal Reserve and ECB ahead of us, the markets can afford to ignore the fundamentals. Not only that, the worse the news, the more the stimulus and, therefore, the better for the markets. Remember also that the Ben-Mario put results in a firm floor for asset prices.
What is likely to happen to asset prices? Analysts have looked at the impact of QE1 and QE2, and tried to extrapolate that to QE3. A note by Citigroup Inc. says global emerging markets went up 80% during QE1 and 18.7% during QE2. Markets also moved up sharply when Super Mario announced his long-term refinance operations late last year.
For the Indian market, the contrast between QE1 and QE2 has been stark. While the MSCI India zoomed 104% in QE1, it went up a mere 8.8% during QE2. Valuations are a major factor determining the strength of the rally, of course, as are oil prices. This time, crude prices are high and valuations aren’t cheap, but the rupee is lower, so that could be a factor driving inflows of risk capital.
In India, another boost to sentiment has been the decision to raise diesel prices. That the government has finally mustered up the courage to bite the bullet is an encouraging sign. Also heartening have been the interest rate cuts by several banks in the recent past.
While the latest rounds of monetary easing will buy some time, the failure of the last two rounds of QE to kick-start the Western economies has led to a lot of questions about the efficacy of monetary easing. The hike in commodity and oil prices as a result of successive rounds of QE is a dampener for the economy. The markets don’t seem to believe that the monetary easing will help the economy much—why else are gold prices going up? And every once in a while, whenever there are signs that the fundamental problems in the global economy haven’t gone away, markets get into a blue funk.
As William White, the Bank for International Settlements economist who predicted the financial crisis, wrote in a recent paper, successive bouts of monetary easing led to the Asian crisis, the dot-com boom and bust, and finally to the current crisis. He argues that the consequence of monetary over-indulgence is that it leads to bubbles, which ultimately burst. Worse, the successive busts keep getting bigger and bigger. The important questions are: (1) Who’s listening? and (2) What is the alternative?