Quantative Easing
Quantitative
easing (QE) is a monetary policy tool used by some central
banks to stimulate their national economies when conventional monetary
policy has become ineffective. The central bank creates
money through open market operations, such as buying government bonds
and other financial assets, in order to increase the money supply and
the excess reserves of the banking system. Quantitative
easing shifts monetary policy instruments away from interest rates, towards
targeting the quantity of money. The term Quantative easing came into lime
light when the US Federal Reserve announced two successive measures on March 18th 2009
and November 2010 so as to boost the ailing US economy from the subprime crisis
and the worst recession since the great depression of 1930’s.
US Federal Reserve is
the central bank to United States created post 1907 market crash in 1913 to
ensure safe and sound financial system. The main aim of the Fed is to review
monetary policy aiming at providing maximum employment and price stability for
a healthy economic growth. At present Ben Bernanke is the chairman to the US
Federal Reserve. Post Lehman Brother Bankruptcy in September 2008 there
was a complete financial meltdown with credit market freezing all over the
world, we saw not only financial giants like Washington Mutual failing but also
countries like Ireland and Iceland went bankrupt. With US economy on its knees
the US Federal Reserve planned out a $720 billion bailout to save the American
economy. With unemployment rising Fed came out with a stimulus package
called Quantative Easing plan on 18th May 2009 to bring back US
economy on path of positive growth.The first round of Quantative easing came
with a stimulus package of $1.7. But it did not prove much useful to the
economy, the unemployment level went from 7.2% to 10.4 % in September 2009. The
US dollar depreciated by more than 11% within few months, though there was some
positive sign in the equity market and again a rising equity market does not
portray the real picture of the economy. Even it had very less effect on the
commodity market as investors remained cautioned on investing in commodities
and with demand of goods falling, commodities were trading at their lowest
point. The demand for crude oil was falling and so was the price though there
was some uptrend seen in the gold with gold trading in the range of $700-$930.
There were several other factors responsible for soaring of gold prices such as
sovereign crisis and unstable equity market people were finding gold as safe
heaven for investment purpose. On the whole QE1 failed to achieve its
objective.
With unemployment rate
soaring in double digit Bernanke came with QE2 on November 2010 , a stimulus
package of $600 to further strengthen the US economy. There was lots of
uncertainty created across the globe as many feared that QE2 will further
depreciate dollar creating a currency war with other large economies. A
depreciated dollar will increase the commodity price in the world market, China
feared the most of the negative impact QE2 would have on the export
competitiveness , similarly with excess liquidity flow in emerging market asset
could cause significant inflation in recipient countries. From here we would
try to analyze the real effect of QE2 on various financial market across the
globe.
Implication
of Quantative Easing 2
QE consists in creating
money and purchasing government debt or other financial assets to add liquidity
to the markets with reduced long term interest rate. As a result of QE the
government has managed to bring back the positive GDP growth while the private
sectors are still weak and contracting. Now i ll discuss the implication of QE
on various sectors.
Increase Liquidity: The most
immediate effect of QE is an increase in the liquidity of the overall financial
system. Private banks and institutional investors have re-directed the cash
received into lending to private businesses or individuals. Alternatively, they
focused on acquiring assets in emerging market there by making profit by
generating revenues on investment made in emerging economies. They also gained
from the predictable appreciation made by local currency against the US dollar.
China has blamed US of devaluating dollars through QE so as to increase its
Global competitiveness. This can also have a negative implication on emerging
economies in the form of soaring inflation.
Equity Market: In November 2010
Ben Bernanke said that "Higher stock prices will boost consumer wealth and
help increase confidence, which can also spur spending." He
successfully attained this goal as US stock market has outperformed major
economies and even developing BRIC nations in past few months till may 2011
though the 3.4% gain this year is still lagging behind its long term historic
pace. However the market is falling since 5 consecutive weeks, its longest fall
since 2004 pulling down the S&P index by 5% and with increasing
unemployment there are further chances of market making a correction by another
5% in coming weeks.
Unemployment: The main main
reason behind these QE was to generate employment in turn strengthen the
economy but after some initial success again the unemployment rate is on
a rise since two weeks and with new regulations imposed by Fed on financial
institution there are chances that major investments giants such as Goldman
Sachs, JP Morgan, Bank of America and Morgan Stanley might go for layoffs so as
to reduce their operating cost. Increasing unemployment rate can hamper US
recovery and can further pull down the equity market.
Housing: Ben Bernanke
aimed at increasing the house prices through QE but after some initial positive
signs the demand is falling and the housing prices has reached its minimum
level since 2005 and there are very little chances of any recovery in near
future, Thus we can see that QE2 has failed even at pulling the economy out of
housing crisis.
Interest Rates: Ben Bernanke has
mentioned that by the use of QE he tends to lower interest rates and help the
housing sector and mortgage lending. From March 18, 2009 to May 18, 2011,
interest rates have risen on the 10-year Treasury from 2.62% to 3.17%, a 20%
increase. Despite that the public debt has increased by 30% during the period,
interest rates have nominally increased about 1% from the record lows in the
10-year Treasury hit during the financial crisis. While the Fed hasn't been
successful in lowering interest rates, it has been able to contain a sharp rise
in them by buying more of a third of the mammoth amounts of debt that are being
offered to the market by the US government. The expected fiscal deficit for
this year totals $1.5 trillion, 9.8% of GDP and an increase of 10% of the US
public debt. With QE part two ending in June, one would expect that interest
rates should start to rise as the market will lose one of its principal debt
buyers.
Commodity Market: QE has has
influenced global commodity prices, dollar depreciation has pushed the
commodity prices. Until 2004, the correlation between commodity price and the
exchange rate was negative. This was because US economy slowdown would normal
cause both the dollar to depreciate and the dollar price of commodity to fall.
In recent years, commodity demands have been driven by large developing
countries. Under the circumstance dollar depreciation, unlike the pat, has been
associated with the increase in commodity price. In 2009, the dollar price of
oil and copper appreciated 1.2% while the dollar depreciated 1%. With Fed
holding a large chunk of US bond, it reduces the supply of safe investment
asset for global institutional investors, reducing the US bond circulation in
the market and low interest rate prompted global institutional investors to
investment in other financial market, commodity market attracting some
investment. Traditionally , investing in commodity market has been a popular as
a mean of hedging against inflation. High inflation brings down the return in
bond and stock market, commodity future tends to do better in times of
inflation. There was seen a sharp rise in the commodity price since 2009 when
QE1 was announced, Gold gaining the most showing a rise by 80% in two years a
rise from $800 to $1530 per ounce. Other precious metal such as platinum gained
too. Overall it was the commodity market that gained the most from QE with
commodity price soaring to new heights.
Forex Market : To fund QE Fed has
to print notes, this increased the supply of dollar in the market there by
depreciating the dollar in term of other currency. This will help US in
recovery as a depreciated currecy increases the competitive advantage in the
world market but on long term it can boost inflation.
Overall QE1 &
QE2 has helped US recover from deep recession of 2008 but the outcome has been
much less than expected and the US finds itself at the same situation as it was
a year earlier with stock market falling and unemployment rising.
QE3 at the Corner
With QE2 coming to an
end in June 2011 there are negative signs from the Fed of a possible QE3
however Bernanke also hinted that if economy growth remain sluggish than the
Fed might go for QE3. End of QE2 will hamper Fed goal of keeping interest rate
low. Low interest rates makes credit cheaper promoting people to borrow,
helping in increasing home prices. With US borrowing limit coming to an end and
congress demanding to reduce deficit and chances of a possible US default on
its payment there are very little chances of QE3 moreover QE3 can have a
catrostrophic effect starting with high inflation.
With no further
quantative easing in sight, the effects are already visible. The most effected
will be commodity market as the price are likely to come down. The most
effected will be gold price, since 2009 when QE1 was announced gold has seen an
uptrend with prices rising from $700 to $1540. Since recession there have been
several factors caused soaring of gold prices. The sovereign crisis and
inflation in major developing nation, gold has attracted the investors the
most. Even though other factors are still the same, the end of quantative
easing will surely bring down the gold prices. Similarly prices of
other precious mental and other commodity will also fall. The price of
pulses, soybean has also been on rise post recession, the commodity future has
given return as high as 36% , but soon these growth rate will ease off.
On the whole the return
from quantative easing has been much less. Bernanke in an interview said that
the Japanese Tsunami has been the major cause for downfall of market
since May and the second half should see a growth pick up. He further added
that there are very less chances of QE3 because a further stimulus can cause
serious problem of inflation however the Fed will continue to keep the
borrowing interest rate at 0.25% to boost economic growth.
