End of the QE experiment and volatility of markets

The problem with any experiment is that they cannot not only fail, but they can create far more harm than what they set out to prove. The market volatility of the last three weeks may be a taste of what is to come


Last week the Japanese Central Bank increased its quantitative easing (QE) program. Markets around the world jumped to new highs like a well-trained dog. This week the European Central Bank strongly hinted that it too would be easing. It did not specifically say how or when, but the suggestion was sufficient to raise market expectations for at least a day. The assumption, which may or may not be correct, is that the markets see the central bank action as stimulus that will help grow economies. While it is true that these programs do grow assets, their real effect on global growth seems to be far less.


Perhaps, the main and immediate result of the Japanese action was to devalue the yen. It fell 2% against the US dollar. Thanks to almost continuous QE, the yen has fallen 32% since 2011. In theory, this has two positive implications for Japan. It raises inflation in Japan by making imports, especially energy, more expensive. Second, it increases exports. But, the theory does not always work so well in practice. Much of inflation created by devaluing the yen comes from making Japan’s main import, energy, more expensive. This hurts the consumer the most and it is the consumer who is supposed to create the demand necessary for more inflation and growth. Secondly, during the years of the strong yen, many Japanese companies placed their manufacturing overseas. So, while the weak yen flatters Japan Inc.’s balance sheet, it does not necessarily create more exports.


Despite all the QE provided by the Bank of Japan, the reality is that growth during the second quarter actually fell by -7.1%. The probability of a rebound in the third quarter is not great. We will know more on November 17th when the preliminary numbers are available.


Devaluing the yen has also impacted on Japan’s trading partners. The Chinese renminbi has a fallen against the US dollar but strengthened against the yen. This certainly does not help the slowing growth in China. After years of stimulus, the present growth is 7.3% down from 7.5% and projected to slow further. Bad loans are rising at the state owned banks. Housing prices continue to fall and 70% of the coal miners are in the red.


A slowdown in China is hardly good news for most of her main trading partners, which include many emerging markets. Falling growth coupled with a very strong US dollar is the worst news for emerging markets since the ‘taper tantrum’ last year. We now have a new buzzword to describe the present situation. It used to be the fragile five, including Brazil, India, Indonesia, South Africa and Turkey. But now, Russia has been added to what is now the suspect six.


These countries generally share current account deficits (CAD) and inflation above 6%. India is probably the best off, but Brazil and especially Russia will have real problems. In a low demand deflationary world with falling oil, gold and commodity prices, those countries that rely heavily on these exports are facing everything from a slow down to a meltdown.


Like Japan, the European Central Bank’s actions and threats have not helped. The European economy continues to slow and deflation continues to spread. The fear that central bank stimulus will create inflation has disappeared. What has not appeared is the realisation that central banks cannot create growth. Not yet.


But that is the reality. Easy monetary policy either is pushing on a string or seriously wrong. Where it has been successful in creating unsupportable asset bubbles is where the real danger lies. As the Financial Times’ John Authers pointed out, is that “an all-time high for the US stock market is a dangerously exposed bet that central banks can shift not only the markets – everyone knows they can do that – but also the global economy.”


The problem with experiments, any experiment, is that they cannot not only fail, but they can create far more harm than what they set out to prove. The market volatility of the last three weeks may only be a taste of what is to come.


(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and speaks four languages.)

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