THE BASIS POINT

The Utter Failure of QE.

As indicated by last week’s extremely weak (+0.69%) 4thQ2015 GDP the economy is weakening. We are in a manufacturing recession. Thursday’s Factory Orders release marked 14 consecutive months of year-on-year decline. One of the problems is that Fed monetary policy (QE) saw too little investment in real assets (plants and other infrastructure) and too much in financial assets.

 
One could make the case that, in fact, these rounds of QE hurt Economic growth by causing a misdirection of spending from real to financial assets. Real assets have longer term risk because they are illiquid to extremely illiquid. It may be the case that monetary expansion without supporting fiscal policy to encourage investments in real assets is what the failure was. Add to this the fact that U.S. corporate tax rates are so high compared to other developed nations that the profits of the big winners still sit offshore and you have the formula for stagnation.

 

Considering the enormous increase in monetary base ($847 billion in August 2008 to $4 trillion on October 2015) and the extended period of near-zero rates the conclusion I draw is that Fed policy has completely failed. Increasing rates in December was essentially the Fed patting itself on the back just as economic growth turned down. As economist Lacy Hunts points out “The trend in economic growth in this expansion has been undeniably weak and perhaps unprecedentedly so. Real per capita GDP grew only 1.3% in the current expansion that began in mid-2009; this is less than one half the growth rate in the expansions since 1790.”

 
I believe that we are stuck with 2% or less real GDP growth for the next 5 years or more. This will dramatically increase the deficit and the National Debt.

 

Why did this failure occur?

 

This is a question too complex to fully answer but most notable the Fed’s expansion of money supply went to increasing the value of financial assets rather than real assets. Instead of building plants, companies borrowed money for stock buybacks to increase share value. The probably-no-longer-to-be-believed wealth (increase portfolio value causes more spending) never happened. Worse yet when QE stopped we will find that the “poverty effect” is more dramatic. The decrease in equity value is causing reduced consumer spending.

 

The good news is that the bad news is worse in Europe, South America and the oil producing nations of the middle-east. Well that is really not good news because the stronger U.S.$ is hurting U.S. exports which is hurting GDP.