We’ve covered QE quite a bit over the years. I’ve repeatedly referred to it as the most over-hyped policy, perhaps ever. After all, it’s just an asset swap of reserves for bonds that doesn’t change the private sector’s net financial assets, perhaps changes interest rates marginally and primarily works via the questionable “wealth effect” it has by getting high frequency traders all excited.
So it was interesting in recent months after QE3 was initiated when some economists started cheering the positive impacts the Fed was having on the economy because the stock market started to rally. The problem is, the stock market is not really a leading indicator of anything. The stock market is the summation of the guesses from a bunch of highly irrational participants using highly inadequate information to place these guesses. Further, the entire premise of a “wealth effect” from the stock market is flawed because the stock market is actually nominal wealth. To make your spending decisions on the current values of the price of Apple or the S&P 500 is a highly unreliable way to earn an income (not that some people don’t do it, but most people don’t). If the policy in QE doesn’t actually translate in a real change to the underlying assets the S&P 500 represents then any nominal wealth changes (as a result of inefficient guesses) will not likely last (thereby creating only a temporary wealth effect) So the impact of this “wealth effect” is highly questionable to begin with. It has a certain ponzi aspect to it similar to a company that just buys back shares perpetually without ever actually investing anything in its underlying operations. That might boost EPS for a while, but eventually the growth of profits needs to be established by more than just fewer shares outstanding.
Anyhow, I rambled on quite a bit there. But as the market tumble a bit here I have to keep asking this question that I’ve been asking since QE3 was initiated. Did the Fed just buy high only to sell lower? QE1 & QE2 were established when the market was cratering. So the market’s response afterwards gave the appearance that the Fed’s policies were highly effective. But QE3 was established after a huge rally in the stock market. Does that mean we will finally be able to put the nail in the QE coffin if the market doesn’t respond as it did following QE1 and QE2? Probably not. Faith in monetary policy is something that will never die. That faith might not be misplaced outside of a balance sheet recession, but in the current environment we’re still betting on a naked emperor….
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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