The implications of easing
Just as the US Federal Reserve (Fed) announced the conclusion of its long-running quantitative easing (QE) programme, the Bank of Japan surprised markets by announcing the expansion of its own easing regime.
Mark Mobius, Executive Chairman, Templeton Emerging Markets Group weighs in on the implications of these central bank actions, as well as current European Central Bank (ECB) policy, and what they could mean for investors on both the equity and fixed income side. First, some background on quantitative easing from Dr. Mobius.
One of the most talked about subjects among global investors over the past couple of years is actually somewhat of a misnomer and typical of the euphemisms common in financial circles: the US Federal Reserve’s (Fed’s) “quantitative easing (QE)” programme. “Easing” really isn’t an accurate description—in actuality, it is about expanding rather than easing. There was QE1, then QE2, and finally QE3, the last version of the Fed’s money-creation program.
QE1 started in late 2008 in response to the US sub-prime financial crisis, in the form of a program to purchase government debt, mortgage-based securities and other assets primarily from banks which were suffering from the decline of the value of those assets. The original program was set at $600bn, but the expected economic recovery and ending of tight credit did not materialize as expected. Hence, QE2 was launched in 2010, and then two years later, QE3, as policy makers became more and more desperate to create the required economic stimulus.
In total, more than $4trn (close to the size of China’s foreign exchange reserves) was spent, about six times the original plan. The result was a three-fold expansion of the Fed’s balance sheet. In my view, what’s most important to note is that the United States was not the only country to launch such a program during these years. In the United Kingdom, a £75bn (about $120bn) program was launched in 2009, and that program was gradually expanded to £375bn (about $600bn). The Bank of England’s balance sheet expanded four-fold; the government was using new money to buy back its own debt.
Subsequently, the European Central Bank (ECB) found itself with the same problem of failing banks. So the same solution has been applied, and the ECB’s balance sheet also has expanded as more and more assets are purchased from European banks.
Of course the Chinese, Japanese and other central banks have launched monetary expansion programs of their own, allowing banks in many respects to be sheltered from having to make tough decisions regarding their bad investments. Meanwhile, much of the money has remained on the banks’ balance sheets, much to chagrin of the central bankers who wanted the banks to initiate lending so the economies would revive. Some of the money has also been diverted into the equity markets as well as property and other tangible assets such as commodities.
The low interest rates we see globally in many markets now disadvantage regular bank deposit savers and pensioners, while the equity holders have generally benefitted as the surviving banks have grown bigger, and perhaps are now in the “too big to fail” territory. The savers who have suffered with low interest rates could be hit with another problem of high inflation down the road.
Although inflation has generally remained low in the markets where central banks have been engaging in easing measures, many—including me— believe that once the banks gain the confidence to begin lending aggressively again, inflation will likely rise. This, of course is a double-edged sword. Countries battling deflationary forces, including Japan and the eurozone—would welcome inflation. But the flip side is that inflation can quickly spiral out of control, and it can hit emerging market economies particularly hard, as a higher proportion of their consumers’ budgets go to basics like food and fuel.
For now, we believe the most recent easing efforts of Japan and the ECB should offset concerns about the end of the Fed’s QE programs and that these efforts will continue to provide liquidity to the markets. But, we’ll be watching for any unwelcome aftershocks.