Monday, 3 February 2014

Two Views on the QE Endgame

By Charlie Henneman, CFA

Ever since the US Federal Reserve initiated a policy of quantitative easing (QE) in November 2008 in response to the deflationary pressures brought on by the global financial crisis, economists and Fed watchers have debated both the efficacy of the policy and what the long-term impact would be on the economy and the global monetary system. Five years later, the debate continues — even as this unprecedented, coordinated intervention has come to define our current era in the global capital markets. Fed Chairman Ben Bernanke’s 18 December announcement that the Fed planned to “taper” its purchases of securities over the following year has not quelled any of these open questions. Nor did it clarify how QE will end.

At the recent CFA Institute India Investment Conference in Mumbai, attendees were presented with two very different perspectives on QE. Avinash Persaud, emeritus professor of Gresham College and chairman of Elara Capital and Intelligence Capital, pointed out that “the first round of QE was crazy, ad hoc, diverse, and it worked.” But later rounds were “largely impotent,” he contended, given that the cash generated by the strategy has failed to reach the economy, instead mostly ending up in central bank reserves or hoarded as cash on the balance sheets of corporations as insurance against future disruptions in the credit markets.

“During the period of QE there has been no gush of cash or wall of money flooding into assets,” Persaud said. “Rather, asset prices have increased because we’re discounting at zero interest rates. The quantity of money has had no impact whatsoever.” In his view, QE has primarily served as a very expensive signal that monetary policy will remain “easy.” For the most part, QE “is purely a communication instrument,” he argued.

So what does Persaud think the market should take from the Fed’s taper announcement?

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