The Consequences of Quantitative Easing
Quantitative Easing Might Have Temporarily Saved the Economy yet Its Effects Could Hinder Economic Progress
The United States Federal Reserve and Central Banks throughout Europe and Japan have resorted to quantitative easing (QE) to prevent economic recessions and a depression. There is no doubt QE stimulates economic activity in the short-term. The pressing question is how this aggressive monetary policy will shape the economy in the coming years. The truth is QE and negative interest rates will spur numerous negative economic consequences as time progresses.
Stimulating the economy with an injection of cash and offering negative interest rates on loans to catalyze spending seems like a decent idea in theory. Though this strategy certainly provides a short-term economic stimulus, it also has the potential to lead to rampant inflation. Money is worth less when there is more of it circulating throughout the economy. This is a major problem for those who have saved their money. It is also a problem in terms of wages. If employee compensation does not keep pace with inflation, labor is worth less, resulting in people working the same amount of hours only to yield reduced spending power. This is precisely why QE was originally thought of as a last resort.
Negative Interest Rates and QE's Inflation Penalize Savers
Why would anyone save when it is possible to obtain a loan at a negative interest rate to spend or invest? Furthermore, there is no incentive to save when QE leads to inflation. Those who put their money in the bank end up on the losing end as their money decreases in value resulting from QE's hyper-inflation. An economy that penalizes savers is an economy that is in serious trouble. It is not healthy or normal for people to continuously spend money and save little or no money. Spending can't go on forever. A healthy economy encourages saving for homes, vehicles and retirement. A populace that is primarily reliant upon government retirement programs for their golden years won't contribute much to the economy once their working years are over. Add in the fact that QE's inflation spikes the cost of living and you have a recipe for an economic disaster.
What if the Money Can't be Paid Back?
It is one thing to lend money at negative interest rates to spur economic activity. It is another for those loans to be paid back in full and on time. The truth about QE is that it is an experiment. No one knows what will happen in the decades that follow. It is certainly possible the loans made at negative interest rates will not be paid back. Just because the banks are pressured to spread money throughout the economy does not make borrowers reliable. Nor does it make businesses that go deep into debt more profitable. It is an inevitability that some of these loans won't be repaid. Unpaid loans combined with inflation is bad news for everyone from the banks to the government and ordinary citizens.
How Pensions can Approach low Bond Yields
Some investment managers believe bonds' low yields should be completely avoided. If interest rates eventually rise, bonds will fall in value. However, short-term interest rate alterations should not concern pension fund managers as their decisions are based on long-term outcomes. Some pension fund managers are adopting a liability driven approach to investing. This strategy makes use of two distinct portfolios with unique goals. The first is mainly comprised of nominal bonds and real return bonds. The second is comprised of equities and a series of active strategies. The former hedges the risks of liabilities such as inflation and interest rates. It makes use of assets that behave in a fashion similar to that of the plan's liabilities. The bottom line is interest rates affect each side of an institutional investor's balance sheet. Develop a strategy that properly allocates funds to bonds and risk will be mitigated.
QE Heightens Income Inequality
There is a serious cultural and PR problem brewing from the economic inequality caused by QE. The Federal Reserve's QE experiment has led to an acceleration in income inequality as the wealthy are provided access to loans, capital markets and profits produced by corporations. The “have-nots” aren't as connected to investments and appreciable assets. Their wages have stagnated while inflation has increased and the cost of living has soared.
What Happens if Another Recession Occurs?
This is the $64 million dollar question. The Federal Reserve and Central Banks throughout the world have exhausted the tools in their economic war chests. QE has artificially floated massive amounts of money into a struggling economy. Loans are being extended to those with questionable qualifications simply because they are willing to take on debt.
One has to wonder if the Federal Reserve will continue to print money and generate even more debt if additional economic recessions arise in the coming decades. If the Federal Reserve continues to buy billions upon billions in United States Treasuries and take advantage of low interest rates, the rest of the world might decide it doesn't want any part of this somewhat unscrupulous activity. Some might even call it a Ponzi scheme. If this economic stimulus does not work, what else can the economic power brokers do to rescue the global economy? There is no concrete answer to this question.
What if QE Fails and Consumers React by Hoarding Cash?
It is certainly possible that people will eventually stop spending and investing as they view equities to be unsafe. Some might become distrustful of banks that recklessly lent egregious amounts of money at negative interest rates and provided the wealthy with easy access to the fruits of the masses' labor. The ensuing response could be a hoarding of cash outside of the banks that reduces economic investment and defeats the purpose of QE.