To Infinite QE and Beyond

A black swan. A doomsday scenario. COVID-19. They are synonymous. A global recession is now inevitable and economic damage control remains key in a global pandemic that has decimated business-as-usual. As of this morning, White House officials have emerged from negotiations confident they will reach a deal by the end of the day on a near $2 trillion coronavirus stimulus package. A vote would closely follow in order to implement the extensive effort to prop up the economy, help households and support the health care system, hopefully stemming the impact on consumer demand, investment and economic growth. On the flip side, monetary response, though delayed in some G10 economies, has overall been quick and impressive. As expected, policy rate cuts were the front line arsenal with QE a supporting act. ECB has launched a €750bn Pandemic Emergency Purchase Package. The Bank of England’s QE programme is now at £650bn. But the mother of unconventional monetary stimulus has been in hiding, till now. In a historic-making moment, the Fed has announced it will purchase an unlimited number of US Treasuries and securities tied to homes and businesses in an attempt to ward off the impending credit crunch. It is no coincidence that this comes after the trillion dollar fiscal stimulus bill has continued to stall. The aggressive and rapid response of the Fed clearly shows they have learnt from the GFC (for instance, the establishment of daily USD swap lines). But there is only so much monetary policy can do in the face of fiscal paralysis and political dysfunction. And we then must question, what are the implications of infinite QE?

Pros

On the positive side, QE will provide quick pain relief to an incredibly stressed and sparsely liquid system lowering interbank and money market rates. Theoretically, it should also help alleviate pressure on the dollar. As the world’s reserve currency, the dollar has seen significant demand and thus appreciation in the past month as investors flock to the safe-haven. QE should therefore provide relief to the dollar and also help the US economy retain a competitive advantage in exports. Emerging market economies will also benefit from a weaker greenback as the overvalued dollar has caused significant roadblocks in the global monetary system, inherently increasing default risk of these smaller EM economies that hold large swathes of dollar-denominated liabilities. Lower rates should also help prop up the stagnating housing market, though critics have notably pointed out this will do little in the face of the subsequent second-order endogenous demand shock that has proliferated from reduced consumer demand and depressed purchasing appetite.

Cons

On the downside, the ability of QE to renew faith in financial markets has been limited and this has been largely due to the fact that markets know the Fed has no more ammo left.The Fed’s balance sheet will also go through the roof and with it the increasing probability of asset bubbles, particularly as the Fed is forced to turn to new asset classes. Powell may have made life nicer right now with infinite QE flooding markets with easy money, but has ironically set up the US economy for another recession when QE stops (and eventually tightening begins) and banks begin to deleverage at record rates. Ultra-low interest rates will also distort capital allocation, keeping inefficient ‘zombie’ companies alive during the looming recession as well as severely disadvantaging pension funds which will see overinflated pension liabilities as a result. One must also not forget about the spectre of long run inflation expectations (maybe even hyperinflation?) in the long run.

The Fed has fired the biggest bazooka so far. Some may even say they are nationalizing financial markets. The unsettling fact now is that the Fed has deployed all possible arsenals in the space of 2 weeks versus 6 months during the GFC. Even now, monetary economists are split over the effectiveness of the post-GFC QE programmes. With the Fed pushed into no-man’s land, anything is possible. The Fed may even resort to post WW2 Treasury yield caps just like Japan, or helicopter money which blurs the political independence of the Fed and the US government. Regardless, the cries for fiscal stimulus get stronger every day. It is clear one can only succeed in the arms of the other – perhaps even paving an ideological shift that sees heterodox Modern Monetary Theory (MMT) become centrefold? Only time will tell.