U.S. money printing.
A fresh round of U.S. monetary easing may even do more harm than good
for long-term investors as another flood of easy money into
fast-growing emerging economies risks refueling oil and commodity
price inflation, sapping consumption and growth.
Prospects for a third round of the Federal Reserve's quantitative
easing program (QE3) grew this month after Chairman Ben Bernanke said
the central bank was prepared to ease further if economic growth and
inflation falter again.
Nearly in one in two fund managers surveyed by Bank of America Merrill
Lynch this month said QE3 was likely.
The temptation for risk-loving investors is to rub their hands with
glee. Traditionally risky or high-yielding assets such as global
equities, energy and commodities and emerging markets surged in the
months after the Fed gave the green light for Round Two of QE -- which
involved $600 billion in new money in the form of Treasury debt
purchases and which ended last month.
But the impact on the U.S. economy and the labor market has been less
obvious, given that growth has slowed significantly into 2011 -- at
least partly because higher energy costs have undermined consumer
spending everywhere. Asset prices, as a result, have retreated sharply
again since April's peaks.
This has given rise to a debate about whether QE3 works. If it doesn't
give a sustained boost to financial markets and is ambiguous for the
real economy, is there any point?
"We have a negative opinion of QE2, and believe QE3 could very well
turn out to be ineffective at best, and counter-productive at worst,"
said Stephen Jen, managing partner of London-based hedge fund SLJ
Partners.
"If we are right, QE will be self-defeating in that the more the Fed
eases, the more commodity prices rise, which erodes the capacity of
consumers to spend on non-energy products and services."
Since Bernanke unveiled the Fed's QE2 bond buying program in a speech
in Jackson Hole in August last year, Brent crude oil have risen 58
percent, while the benchmark CRB commodities index has gained nearly
30 percent.
Developed and emerging stock indexes are both up around 20 percent
since that speech but they are coming off their April highs. On the
year both of them are largely flat.
"My best guess is that there will be a few weeks of positive reaction,
followed by a sell-off, as investors realize the circular and
pointless logic of (the argument that) QE2 could lead to permanent
increases in economic activities," Jen said.
UNINTENDED CONSEQUENCES
Some advocates say quantitative easing works best by revaluing
financial assets so that there will be a positive wealth effect for
U.S. consumers, encouraging them to start spending again. The Fed
argues that it boosts credit in a similar way to an orthodox easing by
directly lowering long-term benchmark borrowing costs.
But the effect of ample dollar liquidity spreads beyond the United
States, largely because emerging economies either are pegged to the
dollar or have inflexible exchange rate policies. Even economies that
do allow their currencies to appreciate are at risk of asset bubbles
as cheap money seeks higher yields.
This means these fast-growing emerging economies effectively import
the Fed's monetary easing and lift their demand for oil and
commodities, whose prices also tend to rise on a weaker dollar.
The other problem is that easy money chasing high-yielding assets
drives hot money into the emerging world, fans inflation and triggers
monetary tightening which in turn slows growth -- creating a vicious
circle.
"If QE3 is simply a repeat of QE2, I don't think it has a positive
impact that has sustainability," said Bob Janjuah, head of tactical
asset allocation at Nomura.
"(It) will make a commodity problem even worse. It won't help the
economy but create a much bigger inflationary pressure.
QE3 will force one globally positive growth area, emerging markets, to
slow down because of inflation ... We could end up with a negative
effect."
Janjuah's preconditions for QE3 are a rise in the U.S. unemployment
rate above 10 percent and a 20-25 percent fall in the S&P 500 index.
As benefits wane, many fear the cost of repeated QE operations could
be self-defeating in that more money printing fuels inflation, debases
the currency and ultimately raises the government's borrowing costs.
According to Jen, the Fed's balance sheet has grown by 10 points to 18
percent of GDP in two years - a similar scale to Japan's in the five
years to 2006.
"The marginal impact of QE is decreasing progressively... The weight
of debt on Fed balance sheet is increasing indeed," said Didier
Saint-Georges, member of the investment committee at private asset
manager Carmignac Gestion in Paris.
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