Failed QE Caused Market Falls?

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The “Black Hole” of QE (courtesy Google Images)

Last Thursday (Aug. 20th, A.D. 2015), the Dow Jones Industrial Average fell 358 points.  The New York Times wrote “China Woes Send Stocks Into Tailspin” in an attempt to blame the fall in US markets on the previous fall in the Chinese stock markets and recent devaluation of the Chinese yuan:

“Stock markets around the world plummeted on Thursday, signaling that investors have not gotten over the shock of China’s devaluation last week and remain nervous about the health of the global economy.

“The selling began in Asia . . . . moved to Europe . . . and ended with a rush for the exits in the United States.

 “The Dow Jones industrial average tumbled 358.04 points, or 2.1 percent, to close at 16,990.69.

“. . . the S&P 500 declined 43.88 points, or 2.1 percent, to 2,035.73, its lowest level in six months . . . .

“The biggest source of uneasiness right now appears to be China’s economy. Many analysts assumed that China’s recent devaluation was in part motivated by a desire to stimulate China’s economy. . . .

“But the devaluation stoked suspicions . . . that China’s economy might be weaker than its official figures suggested.”

 

China is trying to shore up its stock market with a Chinese version of Quantitative Easing (QE).  But will QE work in China?

In fact, will QE work anywhere?

As you’ll read, the answer may be No.

If QE doesn’t and can’t work, what will prevent China’s and the world’s stock markets from falling further?

 

•  The Dow’s decline didn’t end on Thursday.

On Friday, August 21st, A.D. 2015, CNBC wrote “Europe markets plunged 3%; China and oil dominate”:

European stock markets faced severe selling on Friday, with major markets crashing in excess of 2.5 percent, following U.S. stocks lower as worse-than-expected Chinese economic data and a sharp drop in oil prices spooked traders.

“Oil was testing investors’ nerves on Friday, with light crude trading near $40 per barrel . . . . U.S. oil prices heading for its eighth week of falls running on Friday, the longest losing streak since 1986.

“Big falls across Asian stock markets on Friday, after China August PMI data showed that China’s factory activity . . . shrank at its fastest pace in more than six years. The Shanghai Composite Stock Exchange closed over 4 percent lower.”

The Dow had fallen another 531 points.

 

•  But the big news, perhaps the real “bomb” that triggered the global stock market declines, may have been a seemingly innocuous “white paper” released by the St. Louis Federal Reserve on Tuesday, August 18th.

As reported by CNBC.com (“St. Louis Fed official: No evidence QE boosted economy”):

“In a white paper dissecting the U.S. central bank’s actions to stem the financial crisis in 2008 and 2009, Stephen D. Williamson, vice president of the St. Louis Fed, . . . said that:

1) “The zero interest rates in place since 2008 that were designed to spark good inflation actually have resulted in just the opposite.

2)  “The ‘forward guidance’ the Fed has used to communicate its intentions before it acts has instead been a muddle of broken vows that has served only to confuse investors. And, most importantly,

3) “The quantitative easing, or the monthly debt purchases that swelled the central bank’s balance sheet past the $4.5 trillion mark, have at best a tenuous link to actual economic improvements.”

“As for spurring inflation, reducing employment or otherwise generating sustained economic activity, the results, particularly for QE, are “at best mixed.” In addition to muted inflation, the gross domestic product has yet to eclipse 2.5 percent for any calendar year during the recovery, while wage gains, and consequently living standards, have been mired around 2 percent or less.

“There is no work, to my knowledge, that establishes a link from QE to the ultimate goals of the Fed—inflation and real economic activity.  Indeed, casual evidence suggests that QE has been ineffective in increasing inflation,” Williamson wrote.

“For example, in spite of massive central bank asset purchases in the U.S., the Fed is currently falling short of its 2 percent inflation target,” he added. “Further, Switzerland and Japan, which have balance sheets that are much larger than that of the U.S., relative to GDP, have been experiencing very low inflation or deflation.”

 In other words, QE has not only failed to significantly stimulate the US economy, it’s also failed to provide intended “stimulation” in Switzerland and Japan.  This suggests that QE is an inherently failed and ineffective strategy around the globe.

Q:  What is China doing to shore up its falling stock market?

A:  QE.

Q:  What are the chances that Chinese QE will be any more successful than the QEs of Japan, Switzerland and the US?

A:  Near zero.

Q:  Why do nations continue to try to use QE if the evidence shows that it doesn’t work?

A:  Because, in a debt-based monetary system, there’s nothing else they can do.  They’re trapped and left with no solution to fundamental economic problems other than the dim hope that QE might work a little or at least buy some time.

Q:  How could the St. Louis Fed’s white paper have triggered the current global stock market declines?

A:  That hypothesis is a long shot, but the timing is at least coincidentally good (the St. Louis Fed issued that white paper on Tuesday and US markets began to fall on Wednesday). More importantly, the essence of the white paper is the claim and/or admission that QE doesn’t work.

Q:  What does this imply?

A:  First, it implies that if QE hasn’t worked in the past, it won’t work in the future. If so, we have no remedy for the current problems.  Further, the admission that QE hasn’t worked implies that the current economic problem is systemic and can’t be solved until the current “system” is abandoned and replaced by a significantly new “system”.

Q:  If the problem is systemic, what current “system” is so fundamentally flawed that it must be replaced?

A:  Probably, the current, debt-based, fiat monetary “system”.

Q:  If the current, debt-based, fiat monetary system had to be abandoned, what new system might replace it?

A:  Hard to say.  I see two possibilities:

1) The Powers That Be might be able to palm off a “new” monetary system based on “Special Drawing Rights” issued by the IMF.  But, that SDR system wouldn’t be fundamentally “new”.  It would only be another debt-based, fiat monetary system wrapped up in a bright new bow; and,

2) An asset-based monetary system based on something tangible like gold or silver.

The Powers want another debt-based, fiat monetary system in order to exploit the peoples of the world.

The world’s people need an asset-based monetary system to defend them against exploitation by governments and/or central banks.

We shall see which side prevails.

•  “In Williamson’s view, the Taylor rule dictates the level of interest rates in regard to economic conditions. The thinking essentially is that low rates beget low inflation, trapping central banks in zero interest rate policies (or ZIRP).”

In fact, low interest rates are believed to have two, contradictory effects:

1) According to the “Taylor Rule,” low interest rates will cause low inflation rates or even deflation.  Thus, low (Near-Zero) interest rates should have slowed the economy.  But,

2) According to politicians and the Federal Reserve, lower interest rates should have encouraged consumers to borrow more “cheap” currency from the banks and spend it on new homes, cars and flat-screen TVs.  Under that prevalent theory, since A.D. 2008, low (Near-Zero) interest rates should have stimulated the economy and caused it to grow.

The Fed and/or government apparently believed that Near-Zero interest rates would stimulate consumers to borrow and spend at such a high rate that the resulting inflationary effect would more than cancel out whatever “Taylor rule” deflationary effects that follow low interest rates.

The Fed was wrong.  After the onset of the Great Recession, the American people refused to borrow much currency at any low interest rate and therefore didn’t contribute to inflation or stimulate the economy.

Result?  The “Taylor rule” was right.  Near-Zero interest rates caused deflationary forces to become prevalent.  That, in turn, caused the economy to slide towards recession and/or depression, rather than recovery.

•  “With the nominal interest rate at zero for a long period of time, inflation is low, but the central bankers believe that maintaining ZIRP [Zero Interest Rate Policy] will eventually increase the inflation rate. But this never happens.  As long as the central banker adheres to a sufficiently aggressive Taylor rule, ZIRP will continue forever, and the central bank will fall short of its inflation target indefinitely,” Williamson said. “This idea seems to fit nicely with the recent observed behavior of the world’s central banks.”

“Many Wall Street strategists have issued forecasts expecting the Fed finally to end zero interest rates in September. However, uncertainty lingers: The CME’s FedWatch tool, which monitors futures contracts, indicates just a 36 percent chance of September tightening.”

Implication #1:

QE’s 1, 2 and 3 have cost most of $4 trillion.  If QE is now viewed as having been ineffective and having failed to achieve positive results during the past seven years, there’s no valid reason to invest more hundreds of billions of dollars in a QE4.

During the QE3 phase, some gurus chanted the slogan “QE to Infinity”.  That slogan signaled their belief that the US economy had not only become fragile but also become so dependent on QE monetary stimulus, that QE could never end.  But that slogan was based on the presumption that QE actually caused some positive effect.

Written by Alfred Adask
Full report at Adask’s Law

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