Has QE Been Effective?
Former banker and author Satyajit Das answered this question in simple terms as follows.
"In the US, it now requires a government budget deficit of about $600 billion, augmented by injection of about $1 trillion in liquidity from the Federal Reserve, to create about $300 billion of growth."
In input / output terms, the government and the Fed are inputting $1.6 trillion into the economic system annually and in exchange, the economic system is outputting $300 billion of newly created economic value. The output-to-input ratio is under 19%.
Quantitative fund manager John Hussman argues that "the present course of Fed policy is destabilizing the global economy by contributing to a financial environment that encourages the allocation of scarce savings toward speculative activity, not productive investment." Source: http://www.hussman.net/wmc/wmc130527.htm.
Satyajit Das is a former banker and author of Extreme Money, and Traders, Guns, and Money. The above quote is from an article that appeared in the Financial Times on June 18, 2013, page 22.
QE stands for quantitative easing. It refers to the injection of liquidity into the financial system by the US Federal Reserve. Currently, the Fed has been injecting to the tune of $85 billion per month through the purchase of various assets. This translates into just over $1 trillion over the course of 12 months. To give a sense of how big this amount is, it's equal to $7,850 per household, assuming 130 million US households.
Afterthought 1:
History of QE. There have been three rounds of QE. QE1 started in Nov. 2008 at which time the yield on the 10-year US Treasuries was under 3.5%. QE2 started in Nov. 2010 at which time the same yield was under 3%. QE3 started in Sep. 2012 at which time the same yield was above 1.5%. Prior to any QE and right before the first signs of financial troubles emerged, which was in mid 2007, the same yield was it its highest at above 5%.
Today, June 21, two days after the Fed announced plans for tapering QE3, the same yield stands at 2.4%. The Fed indicated that QE tapering could start as early as in September of this year and that QE was likely to end by the middle of 2014. The Fed said it didn't plan to raise interest rates until the middle of 2015.
In the last couple of months, the 10 year US government bond yield hit a low of about 1.6%. The move from 1.6% to 2.4%, which is a rise of 80 basis points, translates into a price drop of about 6-8% (depending on the bond's actual coupon). The smaller the coupon, the higher the bond's duration, and therefore, the larger the price drop in relative terms.
The relationship between bond yield changes and bond price changes is captured by duration. See for example the Wikipedia article on bond duration. For example, the duration of a bond maturing in 10 years is somewhere around 5 to 7 years, depending on the coupon. The larger the duration, the more sensitive is the bond price to interest rate changes.
Question: What is the duration for stocks? Stocks have a much longer duration than bonds, perhaps 6 - 30 times larger. See for example the Wikipedia article on stock duration. This means that they are that much more sensitive to interest rate changes. All else being equal, a rise in interest rates due to Fed tightening could send the stock market down more than one would think.
Afterthought 2:
Question: How much liquidity have the developed world's central banks injected into the economy in aggregate?
Answer: G7 central banks have collectively put some $10 trillion of additional liquidity into the system since 2008, according to JP Morgan and Deutsche Bank estimates.
Afterthought 1:
History of QE. There have been three rounds of QE. QE1 started in Nov. 2008 at which time the yield on the 10-year US Treasuries was under 3.5%. QE2 started in Nov. 2010 at which time the same yield was under 3%. QE3 started in Sep. 2012 at which time the same yield was above 1.5%. Prior to any QE and right before the first signs of financial troubles emerged, which was in mid 2007, the same yield was it its highest at above 5%.
Today, June 21, two days after the Fed announced plans for tapering QE3, the same yield stands at 2.4%. The Fed indicated that QE tapering could start as early as in September of this year and that QE was likely to end by the middle of 2014. The Fed said it didn't plan to raise interest rates until the middle of 2015.
In the last couple of months, the 10 year US government bond yield hit a low of about 1.6%. The move from 1.6% to 2.4%, which is a rise of 80 basis points, translates into a price drop of about 6-8% (depending on the bond's actual coupon). The smaller the coupon, the higher the bond's duration, and therefore, the larger the price drop in relative terms.
The relationship between bond yield changes and bond price changes is captured by duration. See for example the Wikipedia article on bond duration. For example, the duration of a bond maturing in 10 years is somewhere around 5 to 7 years, depending on the coupon. The larger the duration, the more sensitive is the bond price to interest rate changes.
Question: What is the duration for stocks? Stocks have a much longer duration than bonds, perhaps 6 - 30 times larger. See for example the Wikipedia article on stock duration. This means that they are that much more sensitive to interest rate changes. All else being equal, a rise in interest rates due to Fed tightening could send the stock market down more than one would think.
Afterthought 2:
Question: How much liquidity have the developed world's central banks injected into the economy in aggregate?
Answer: G7 central banks have collectively put some $10 trillion of additional liquidity into the system since 2008, according to JP Morgan and Deutsche Bank estimates.
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