CAUSES AND EFFECTS - CONT'D
QE bank de-capitalization - Achieved
However what happened was "slightly" different. Yes, Central Banks bought garbage from banks at nominal prices and thus zombie-banks became living banks yet again. However, banks did not loan the now massive amounts of cash in their vaults. They were afraid a new 2008 was just around the corner. And so little to no economic stimulus was achieved. However, having cash sitting in vaults is not good for banks' profits. Thus banks loaned… just not to the expected customers. They loaned to countries offering very high interest rates, typically above 10% (compare this to ZIRP and you may notice the appeal). And so banks loaned to virtuous customers such as the Greek government…because we know how reliable such borrowers are! Thus, banks became bloated yet again with worthless paper de-capitalizing themselves in the process. Neat right? Full circle.
QE moral hazard preserved - Intended
Moral hazard is the idea that if a financial institution is stupid and makes bad economic decisions, the government will rescue it. This triggers the notion that no matter how bad a decision, there is no risk in it since the government is always there to ensure nothing ugly will happen. In a risk/reward situation, the government removed all the risk thus prompting banks and financial institutions to look only at potential profits. Leverage levels were up to one to 10, 100, 100….. 10.000.000 and more! Crazy right?
One of the elements of QE was to rescue big banks while leaving smaller ones to die. Many banks failed in the subsequent years following 2008. This was supposed to keep the moral hazard issue at bay. See? They would say. We are not rescuing troubled banks. Let the forces of the free market take care of failed enterprises.
QE moral hazard discarded - Achieved
The reality was quite different. Central Banks did bail out large banks, to the point that a new phrase was coined "too big to fall". And this represented the epitome of anti-moral hazard. All those tiny banks that were allowed to die represented only a miniscule amount of wealth held by 5 or 10 mega-banks throughout the world. Moral hazard was not applied to these monster-institutions. As a consequence, they did what one would expect them to do. They lent to dubious borrowers and gorged themselves in highly risky derivatives. BTW, this is the origin of our historical all-times high amount derivatives currently present in the world (see for example The 1.5 Quadrillion USD Bet - What Can Possibly Go Wrong).
QE mild inflation - Intended
One of the basic ideas in Monetarist/Keynesian theories is that a little bit of inflation is good. Thus, Central Banks always attempt to have inflation within a specific range. QE is intended to increase inflation as banks (now flush with cash) begin to lend. Through this lending process they increase the amount of circulating money about 10 times (see for example Central Banks Engines Of The Evil Empire). And as few banks are lending to few customers a few amounts of money, we are witnessing a little bit of inflation.
QE mild inflation - Achieved
The primordial problem with this view is that inflation is a really, really bad thing. Inflation is not a natural market process, deflation is. Inflation is always bad while deflation (if not produced through artificial means) is always good. The idea that a little bit of inflation is required is actually robbing people from whatever hope they may have. They are still in the middle of a devastating economic catastrophe with no jobs (and no earnings) in sight. In the middle of this debacle comes the government telling them that everything going up in price due to inflation is a "good" thing. Crazy right?
But it gets worse. The amount of money that Central Banks have printed and released into the banking system is at all times high. And what have they achieved in terms of inflation? Basically little to nothing. The devastation that all that money will create in the future cannot be justified under any circumstance by declaring that was necessary in order to have "good" inflation of 2 to 3% per year. Ridiculous! Yet, here we are.
QE neutral inflation - Intended
There is yet another side of inflation that we need to explore. According to Central Bankers, inflation is "neutral". It does not go to specific assets. It permeates the economy holistically. No economic sector is particularly affected. Thus, what is not to like about inflation since there is no risk, right?
QE asymmetric inflation - Achieved
However, reality is quite different. It so happens that people are not stupid and they realized early on that real stuff, tangible stuff has value while coloured paper and ones and zeros in bank accounts mean nothing. Thus, they borrowed at ZIRP (remember ZIRP?) to buy all kinds of assets. These included houses and stocks. See where we are going? All that money Central Banks printed and released into private banks are now fueling a crazy increase in prices in real estate and stocks. This is called "asset inflation". These sudden and crazy increases are also called "bubbles" in common wording and according to Greenspan (and other Central Bank luminaries) they cannot be forecasted. Right! The problem with bubbles is that they all eventually pop leaving people with huge debts and insufficient assets to pay them off. Instant personal bankruptcy. And what happens to banks? Same. They must write those loans off. Lose-lose.
QE market clean-up averted - Intended
As we explained previously, QE is intended to salvage big banks in trough the "liquification" of their "unproductive" assets (i.e. buying garbage and paying full price). This is done on purpose because it is believe that without these institutions the entire market system would collapse. Thus, we have organizations that are "too big to fail". In those cases, the normal market processes must not be allowed to take place "for the greater good". And what will happen in the future? Those organizations will become well-behaved as the economy begins to improve. They will do so because interest rates will raise from ZIRP and there will no more need for ludicrous leverage levels just to maintain profitability.
QE market clean-up averted - Achieved
The reality is, of course, vastly different. The process known as bankruptcy is the mechanism markets have to get rid of organizations that waste capital and resources. It is a process that recognizes a bad enterprise and cuts its loses before it can make more damage to healthy organizations. By interfering with this mechanism Central Banks are ensuring that inefficient, ineffective, wasteful and downright dangerous financial organizations continue to operate. Not only that, they operate at a larger and larger scale sucking in capital that could be put to use more effectively somewhere else. The irrational fear of bankruptcy is founded, but it is erroneous.
The fear is based on what's called "cascading cross defaults" or "credit freeze". What this term means is that as all companies are tied together through credit, should big players begin to shut down, one shut-down will lead to another and another and another until there is no company left standing. A world-wide domino effect. That's the worry and it should be. However, it is taken out of context. We must remember that in bankruptcies (even large ones) true wealth is not destroyed, it simply changes hands. What is destroyed is the worthless assets that were in the books but were…well…worthless to begin with. As such even in a world-wide domino effect, this problem would be sorted out fairly quickly. This is so because the larger the bankruptcy, the larger the business opportunity. Think about it. If you local bread maker goes out of business, you won't benefit too much from the sale of their assets. However, if a local supermarket gets bankrupted, chances are you will find something you really like at a deep, deep discount.
The bottom line is that even in this world-wide domino effect, things would be cleaned-up pretty quickly. Don't believe us? You are right in so doing. We could be mistaken. Just check reality. We give you Iceland. They allowed big players to go bankrupt. Nothing horrible happened. Hummm…..
QE good inflation - Intended
As we mentioned previously, QE is intended to create inflation; just the right amount. In terms of Monetarist/Keynesian thinking, it is known that printing will create inflation with a delay and too much inflation is destructive. Thus, at some point in the future "excess" inflation needs to be "mopped-up" to prevent an "overheating" of the economy (i.e. an orgy of market activity artificially spurred by easy money). Thus, at some point in the future interest rates will have to be raised. No problem. Everything will be under control.
QE oscillating inflation - Achieved
There is only one tiny issue with this process; it is bollocks! To our knowledge in the entire history of all countries in the world over the last 200+ years there has been only on occasion where a "soft landing" was achieved. This was in US during the Greenspan era. One in 200+ years. What economists refer to when they speak about "soft landing" is the idea that undesirable inflation can be eliminated without creating an economic recession. Think about it. If a Central Bank is pumping money into the markets, the markets respond accordingly and become dependent upon this money. If the money is reduced or cut-off, markets will retract and create a recession. As history proves, this is almost impossible to achieve. In reality what we have is overshooting and undershooting. Either "too little" inflation is created or "too much" inflation is observed. It almost never works. Meanwhile, you have to ride the rollercoaster!
QE hyperinflation averted - Intended
Part of the previously described process of "soft landing" is the idea that no matter how much money one pumps into the economy, it is always possible to raise interest rates so much that hyperinflation can be averted. Case in point is that most hyperinflation cases happen in non-developed countries. It is obvious that they don't know how to properly manage an economy. There is no risk here.
QE hyperinflation will happen - Not Yet Achieved
So far their position seems to be in line with current economic conditions, but the question is if this will last. We won't keep you in suspense, it won't. All non-developed countries have exactly the same tools that Central Banker in developed ones have. They all use them. This is not rocket science yet, somehow, we see bouts of hyperinflation sprouting up here and there all the time. What's going on? Simple. The current scenario is that a most money pumped into the banks is still sitting in banks, there will be no hyperinflation. But at some point in the future, banks will begin to loan simply because they must or go broke. When this happens, inflation will inexorably begin to creep up and up and up with no ceiling in sight. How high will it go depends of the amount of previously printed money. Even if the government stops printing (fat chance), we will still have hyperinflation. As interest rates rise, people tend to deposit their money in the bank because of high returns of investment. But banks cannot "deposit" their money and get even higher returns (which they would need to make a profit). Thus, they loan this money at astronomical interest rates and the companies taking those loans can only pass those expenses to the consumer… who experience even higher inflation rates! It is a self-reinforcing mechanism on steroids. There isn't a single country in the world, ever, that managed to come out from hyperinflation through market adjustments performed by Central Banks. The only way out is a shock…involving a total change in currency and a complete stop to printing…for a little while. Hyperinflation is inevitably in our future. The only question is when and what will governments do.
Note: please see the Glossary if you are unfamiliar with certain words.
