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Will QE in reverse also be a “non-event”?

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You have typed many words about the impact of QE, e.g. the lack of actual economic change, but an exaggerated impact perceived by the market. Will we have a lack of actual economic impact by QE in reverse? Our friend Ben Bernanke has commented on this -QE. He is again expecting an exaggerated impact perceived by the market. Are you?

Shrinking the Fed’s balance sheet

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Posted by Dennis
Posted on 01/27/2017 4:29 AM
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Bernanke has been very good describing the effects of QE. Personally, I don’t think the markets responded to QE2 and the other iterations much. QE1 was a little different because of the unusual environment. But QE had diminishing returns.

Regarding the unwind – as BB explains, the Fed has no urgency here. They aren’t going to sell the assets in a fashion that would disturb asset prices. So they can afford to be patient and just let them mature naturally. There’s no reason to think this will cause any market disturbance at all. In fact, if anything, it means more net income for the private sector as we now get to hold more of the high yielding assets that the Fed has been hoarding. The Fed’s balance sheet unwind is actually a good thing in my opinion.

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Cullen Roche Posted by Cullen Roche
Answered on 01/27/2017 2:08 PM
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    I’m of the view that QE was very helpful in all of its forms. Why do I say this? Cuz after QE, the current account deficit collapsed from ~6-7% of GDP to <3% for the entire period it was done. QE is just an asset swap for the private sector where capital assets are swapped out for straight cash on the asset side of the private sector. So the entire point is to create a pile of cash on the asset side of the private sector balance sheet looking for somewhere to go. The effect of such a policy is to simply create speculative capital outflows into other countries with higher risk profiles (primarily emerging markets). When you create capital outflows, that reduces your capital account surplus which necessarily implies a drop in the current account deficit. So I disagree with Cullen's view that QE wasn't effective after the first round.

    With regards to QE reversal being a "non-event", I'd be careful to say that. Now that the Fed is targeting the short-term money market rate of interest instead of the monetary base, QE is automatically reversing. The size of the Fed's balance sheet has been falling since the Fed has started to hike rates (see link below). However, this impact will be felt in regions and industries taht're reliant on rolling over debts with cheap credit. The Fed raising rates will create problems in emerging markets. A lot of countries could have problems, especially if they're reliant on high commodity prices.
    https://fred.stlouisfed.org/series/BASE

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    Posted by Suvy Boyina
    Answered on 01/27/2017 8:37 PM
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      QE also results in a form of seigniorage for the government. When the Fed buys assets, it does so by issuing a liability (currency in the system or M0). So the Fed has bought Treasuries or MBS’s that return something like 4-7% while it pays .5% IOR on deposits held at the Fed. That spread goes straight to the Treasury. It amounts to ~$100-200 billion/year.

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      Posted by Suvy Boyina
      Answered on 01/27/2017 9:00 PM
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        I have never seen any evidence that QE caused inflows to stocks. Certainly not international stocks. Besides, several foreign central banks are and have been doing the same programs. Why would the USA be the net outflow region in a world where other central banks are buying even more than the Fed? That just doesn’t make logical sense.

        Also, the remittance to the Fed reduces the size of the budget deficit. This isn’t a “gain” for the govt. It’s a decline in net issuance of safe financial assets to the private sector.

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        Cullen Roche Posted by Cullen Roche
        Answered on 01/27/2017 9:59 PM
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          The Fed policy actually tracks EM and commodity prices pretty well. Commodity prices and many EM currencies started to come under lots of pressure as soon as the Fed stopped expanding M0 in 2014. Of course, EM currencies and asset prices are heavily tied to the movement of commodity prices. It all seems to track the Fed pretty well.

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          Posted by Suvy Boyina
          Answered on 01/28/2017 3:34 AM
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            I never said QE created inflows into stocks. I said QE created speculative capital outflows into emerging markets. It helped really drive their asset markets. I remember a 5-6 years ago when emerging markets were the place to be due to their very high growth rates.

            Foreign central banks have taken up similar policies, but the only institutions which can even create large enough distortions relative to the Fed are the ECB and the PBoC. Of course, China has capital controls. From what I’ve seen the ECB is purchasing assets at the same rate since 2014. Also, the Euro isn’t the world’s reserve currency. The USD is the reserve currency.

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            Posted by Suvy Boyina
            Answered on 01/28/2017 3:43 AM
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              I also didn’t say that the US was a net outflow into the region. I merely said that the outflows generated from expansionary monetary policy from the Fed imply that the capital account surplus would be less than it otherwise would’ve been. That implies a smaller current account deficit, by definition.

              There’s two ways to affect the trade balance. One is by policy that affects trade directly. The other is by shifting international capital movements which must end up affecting trade indirectly. If you create a pile of cash and some of that cash flies out of the country, that reduces the net capital inflows into your country. Hence, your current account deficit must fall. How it falls and the way it impacts multilateral trade between countries is very unclear, but the accounts must balance at all times.

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              Posted by Suvy Boyina
              Answered on 01/28/2017 3:51 AM
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                Sure, but where’s the evidence that QE is causing capital movement? People always say this about the stock market – “the stock market is booming during QE which must mean the Fed is manipulating stocks!”

                I just don’t think you can assign the causation because you see a correlation. I mean, maybe the cause is just good old valuations and the fact that foreign markets look much more reasonably valued? In either case though, I think it’s relatively irrelevant. QE didn’t shrink the current account balance. The financial crisis did most of the heavy lifting there. Since Q1 2009 the current account balance has been flattish so that is totally consistent with my view that QE’s later iterations had very little impact. If you were right then the current account should have continued to improve all through the later iterations of QE, but it didn’t…..

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                Cullen Roche Posted by Cullen Roche
                Answered on 01/28/2017 2:06 PM
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                  Here’s the visual:

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                    Cullen Roche Posted by Cullen Roche
                    Answered on 01/28/2017 2:12 PM
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                      Wasn’t the financial crisis counteracted with QE? We began QE in 2008, didn’t we? I don’t look at the current account balance in terms of net dollars. I look at it as a portion of GDP. The financial crisis certainly did knock off a large part of that current account deficit, but remember that commodity prices/energ fell and then rose after 2008. After QE, the current account balance held flat even though commodity prices and energy prices dropped while the US was producing roughly the same amount, if not more, in terms of energy.

                      It’s not necessarily that it caused it to fall. It’s that it ends up netting out with other capital and trade flows. I do think the current account balance would’ve been higher than it otherwise would’ve been without QE.

                      But I do think you’re correct in many parts. There were other factors in play, but QE didn’t hurt. Also, US military spending fell from drawdowns in Iraq and Afghanistan. There were a lot of different factors in play, but it all has to net out.

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                      Posted by Suvy Boyina
                      Answered on 01/28/2017 10:23 PM
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                        Wasn’t the financial crisis counteracted with QE? We began QE in 2008, didn’t we? I don’t look at the current account balance in terms of net dollars. I look at it as a portion of GDP. The financial crisis certainly did knock off a large part of that current account deficit, but remember that commodity prices/energ fell and then rose after 2008. After QE, the current account balance held flat even though commodity prices and energy prices dropped while the US was producing roughly the same amount, if not more, in terms of energy.

                        It’s not necessarily that it caused it to fall. It’s that it ends up netting out with other capital and trade flows. I do think the current account balance would’ve been higher than it otherwise would’ve been without QE.

                        But I do think you’re correct in many parts. There were other factors in play, but QE didn’t hurt. Also, US military spending fell from drawdowns in Iraq and Afghanistan. There were a lot of different factors in play, but it all has to net out.

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                        Posted by Suvy Boyina
                        Answered on 01/28/2017 10:23 PM
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                          Yes, I’d argue that QE helped more than it hurt. I guess my main point all these years is that QE was seen as a bazooka when it was more of a water pistol. And because we thought we were firing a bazooka we ignored all the other weapons we had in the arsenal.

                          I know I probably come off sounding like an extreme critic of monetary policy, but that’s not my intent. I just think there were better ways to combat this particular economic downturn and QE wasn’t it….

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                          Cullen Roche Posted by Cullen Roche
                          Answered on 01/29/2017 1:31 AM
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                            > In fact, if anything, it means more net income for the private sector as we now get to hold more of the
                            > high yielding assets that the Fed has been hoarding.

                            I thought the Fed didn’t compete with the private sector for the money supply? :)

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                            Posted by MachineGhost
                            Answered on 02/11/2017 3:39 PM
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                              I agree that correlation is not causation. If QE caused outflows into emerging market stocks which are all highly correlated to commodities, then it is no different than the anti-USD capitalo flows that rallied gold into the Stratatosphere. And you didn’t even need to leave home for that!

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                              Posted by MachineGhost
                              Answered on 02/11/2017 3:41 PM
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