The Federal Reserve began Quantitative Easing six years ago. It’s the new conventional prescription to make economies grow. The central banks simply create new money and buy government bonds. Many economists believe it helped keep the US and other countries that used it like, Japan and the UK, from falling into a catastrophic depression. Now the 19 nation euro area known as the European Union’s Central Bank is pressing ahead with its own full-blown version of QE. Governments and their central banks are pulling out all of the stops to create a “Goldilocks economy – not too hot, but not too cold,” as observed by BBC News. You are familiar with one of the main tools to control growth is by raising or lowering interest rates. Low interest rates encourage consumers and businesses to spend money as opposed to save money. For our YouTube version, please watch:
What is QE?
But with the belief that the government can turn the economy into a machine, there is a supposition that there must be a way to set the thermostat in the room that will automatically determine when to blow cool or warm air to keep the environment comfortable. When interest rates are almost zero, central banks have adopted a new tactic, such as pumping money directly into the economy. A central bank buys assets, usually government bonds with money it has printed electronically. This money is used to buy bonds from investors like banks and pension funds using the new money. The theory is that the increased amount of money in the financial system encourages financial institutions to lend money to consumers and businesses. The by-product is that both groups will spend and invest more which should lead to growth in the economy.
Inflation vs Deflation
Investors can well remember the early 1980’s when you enjoyed double digit interest rate returns on certificate of deposits as well as real estate. Real estate owners were gleeful that by the time the purchase of a home closed escrow, it was already worth more money. This time is different. Deflation is when prices on things go down. This situation alarms governments as they have no tools to deal with falling prices. When businesses and consumers experience deflation they put off buying things in the belief that prices will continue to fall further, so why buy now when waiting will make purchases less costly. This becomes a downward spiral when it comes to sales and growth. You may have noticed earlier this year the World Bank warned that the Eurozone risked sliding into permanent stagnation.
“So you thought quantitative easing was over? Think again” was seen on PBS Newshour. Most people believe the Federal Reserve ended its bond buying program in October, 2014. The central bank purchased $4.5 trillion worth of mortgage-backed securities and Treasury bonds, according to the same source. Economist Terry Burnham says the idea that the purchases are now at zero is not that simple, The Fed has continued what he called “Stealth QE” or “the purchase of more bonds with the interest the Fed earns on the bonds it has already purchased.” In order for that practice to be zero, the Fed “would need to shrink its balance sheet by the amount of interest that it earns,” he writes. Mr. Burnham has been a critic of the Fed’s bond-buying scheme for a long time. He now teaches at Chapman College and is a former Goldman Sachs trader, biotech entrepreneur, money manager, and economics professor at Harvard’s Business School and Kennedy School of Government. His most famous prediction is that “the Dow will hit 5,000 before it hits 20,000.”
Smoke & mirrors
As the Federal Reserve printed trillions of dollars to keep the economy on auto-pilot, and with the stock market at historic highs, many investors have concluded that the fundamental problems discovered in 2008 have been properly addressed, so we can all enjoy being on the happiest place on Earth. But Alan Greenspan, the man who is known for being the architect responsible for domestic monetary policy, who served under four US Presidents, has a different point of view. Thanks to zerohedge.com and veteran resource analyst Brien Lundin who visited with Mr. Greenspan at the New Orleans Investment Conference recently, “the central bank is facing a serious problem and one that will have significant ramifications in the future,” said Greenspan. Lundin asked him about the outstanding government debt load. Greenspan responded, “The era of quantitative easing and zero-interest rate policies by the Fed…we really cannot exit this without some significant market event…By that I interpret it being either a stock market crash or a prolonged recession, which would then engender another round of monetary relation by the Fed.” According to Alan Greenspan, there will be a “significant market event. Something big is going to happen.”
As powerful as governments are today, they are not able to out-engineer life. The economy is analogous to life. It is like a living and breathing animal. Animals respond to various life cycles, like the weather. Winters can be very severe where some things and some people die, but winter serves a purpose. I have spent some time going to school in Minnesota and I know about -40 degree temperatures. I also know, just like you do, that spring always follows winter. But as those of us from California were warned by the Northfield, MN locals in the middle of those beautiful and warm Indian summers dressed in our flip-flops, OP shorts and polo shirts, you better get ready for the winter.The opinions in this article are for general information only. They are not intended to provide specific advice or recommendations for any individual. To determine which investments may be appropriate for you, consult with your financial professional. Please remember that investment decisions should be based on an individual's goals, time horizon, and tolerance for risk. Neither an investment strategy nor rebalancing can guarantee a profit or protect against a loss. Securities licensed associates at Investors Advantage are Registered Representatives & Investment Adviser Representatives. Securities and investment advisory services offered through NATIONAL PLANNING CORP. (NPC), NPC of America in FL & NY, Member FINRA/SIPC, and a Registered Investment Adviser.Investor's Advantage Corp. and NPC are separate and unrelated companies.