An Infinite Supply of Money? | Value Research With an apparently indefinite extension of QE on the cards, we're in an uncharted territory
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An Infinite Supply of Money?

With an apparently indefinite extension of QE on the cards, we're in an uncharted territory

Five years ago, a lot of people had noted that the global financial crisis had taught all of us a new term, which was 'subprime'. With time, we have had other additions to our vocabulary, one of them being 'Quantitative Easing' or QE, and lately, QE's evil twin, 'tapering'. Equity traders have learned that QE is something good because it involves the US Federal Reserve pouring money into the world economy. When the Fed does that, some of this money ends up in our stock markets and keeps them from collapsing. Back in July, the Fed chief Ben Bernanke first stated that QE would be reduced--tapered off, the now-infamous term--on a definite timetable. All kinds of markets around the world reacted badly to this news. In India, every kind of market--equities, bonds and most of all the rupee--reacted sharply on the belief that tapering would be very bad news indeed for India.

A month later, apparently scared by the mayhem brought about by the mere mention of tapering, the Federal Reserve backed off as Bernanke let it be known that tapering would be delayed by at least some months. Last week, yet another very substantial nail was driven into tapering's coffin. The next head of the Federal Reserve, Janet Yellen, who will take over in January for a term of three years made it clear that as far as she was concerned, tapering was not an idea whose time had come. In confirmation hearing for her appointment before the Senate Banking Committee, Yellen said that the US economic recovery was still weak and that strong measures were needed to support it.

In India, we're all now well aware that the monetary policy consists of setting interest rates. In simple terms, there is a growth-vs-inflation trade-off that the central bank is supposed to be able to influence with interest rates. If inflation is too high then the bank increases interest rates which can bring it down but at the cost of growth. If growth is too low then the bank would lower interest rates. That's what normally happens anyway--whether it works in India's particular situation this time around is an experiment we are all living through.

However the US is in a different situation since the financial crisis because its interest rates are effectively zero. So to boost growth, the Federal Reserve can't push them any lower. Instead, it has resorted to adding liquidity to the economy. This means quantitative easing, which actually amounts to pouring USD 85 billion into the economy every month would continue for the foreseeable future.

So what is this foreseeable future, in terms of actual months and years? Here's where the plot has now started thickening. The last four months have made it clear that as far QE has become a tiger on whose back the Fed is riding. If the idea is that QE can be tapered off when growth is more robust, then that actually means that it can be tapered off when there's widespread confidence that growth is robust. However, what if the confidence amounts to a belief that growth depends on continuous QE? Then QE starts looking like a trap. The interesting part is that in recent days there has been a sudden buzz around the idea that QE is effectively permanent.

Last week's renewed enthusiasm by Indian stock markets is a direct result of this long lease of life that QE has got. The expectation is that the money will keep flowing out of the Fed's coffers and the FIIs will keep buying at least some stocks. Unfortunately, this is a poor basis for stocks to rise upon. We'll have a robust equity market on the basis of two things--when economic growth resumes and corporate performance starts improving; and when a much larger number of Indians start actually start investing in the market. Both these events are probably some time off. Till then, it's going to be all about QE and tapering and perhaps some more new words that we'll be forced to learn.

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