Wednesday, November 20, 2013

Quantitative Easing - Winners and Losers Part 1

With Janet Yellen poised to take over the helm of the Federal Reserve, the bond and stock markets are wondering what lies ahead for the five year Bernanke experiment.  Whether to taper or whether to continue with the status quo, that is the trillion dollar question.  As well, one could question what impact this unprecedented and unconventional monetary policy has had on the world's economy, particularly how ultra-low interest rates have affected the prices of different classes of assets, whether these policies have boosted the wealth effect and pushed up consumption and how the policies have impacted the flow of capital to emerging economies.

A fascinating study "QE and ultra-low interest rates: Distributional effects and risks" by McKinsey Global Institute (MGI) looks at the impact of quantitative easing and the current near-zero interest rate policy on different sectors of the economy in terms of interest expense and interest income in the United States, the United Kingdom and the Eurozone.  The sectors in the study include central governments, non-financial corporations, banks, insurance and pensions, households and the rest of the world.  I will split this important topic into three parts for easier "digestion"; in Part 1, I will look at the actions that  four key central banks have taken since it looked like the world's economy was certain to collapse in 2008 and give my readers some idea of just how unique the current situation is compared to history.  In Parts 2 and 3, I will look at how all of the actions taken by these four central banks have impacted the aforementioned sectors of the economy both positively in Part 2 (the winners) and negatively in Part 3 (the losers).

Let's start by looking at the actions taken by the world's major central banks in the United States, the Eurozone, the United Kingdom and Japan.  First, let's look at the conventional methods used back in late 2008 and early 2009 (i.e. buying and selling short-term government securities and collateralized repurchase agreements) to force interest rates to their zero lower bound:

Save for a short period of very slightly higher rates implemented by the ECB, interest rates in all four cases have remained very close to zero since 2009.  Once the central banks expended their conventional source of "ammunition", they were forced to employ unconventional methods including quantitative easing and "The Twist" through the large scale selective purchase of assets of various terms that were intended to force flattening of interest rates along the entire maturity curve.  Thus far, the Fed has used three asset purchase programs termed QE1, QE2 and QE3 along with Operation Twist", the Bank of England has purchased £375 billion of gilts, the ECB has purchased sovereign debt and the Bank of Japan has set up a program that will allow it to purchase up to ¥76 trillion worth of government bonds per year which would more than double its holdings over the next two years.  As a result of all of these measures, this is what has happened to the balance sheets of the four central banks from 2007 to Q2 2013:

In total, the balance sheets of these four central banks have risen by $4.7 trillion or 127 percent since 2007.  Notice that the compound annual growth rate of the balance sheets of the four central banks over the past five years has been in excess of 16 percent and this does not account for the ongoing asset purchases of the Federal Reserve and the Bank of Japan which has now pushed the total up by at least another $500 billion!  You will also note that the balance sheets of the four banks now makes up 24 percent of the combined GDP, up from a relatively measly 11 percent in 2007.

Here's what has happened to the Federal Reserve balance sheet which has grown from $870 billion in 2007 to its current level of $3.907 trillion:

Here's what has happened to the Bank of England balance sheet since the beginning of 2009 which has grown by £375 billion since early 2009:

Here's what has happened to the ECB balance sheet since 2002:

Here's what has happened to the Bank of Japan balance sheet since 1989 noting that the Bank of Japan has been using QE since the mid-2000s to rather unsuccessfully prod its economy out of its doldrums:

The Bank of Japan has seen its assets balloon from ¥20 trillion at the beginning of 2007 to ¥217.7 trillion by November 2013, an increase of 1089 percent over just under 7 years.

Here is a bar graph showing how each of the four banks has used different methods to achieve the same goal of pushing and keeping interest rates low:

All but the ECB have used massive purchases of government debt (dark blue).  

In addition, central banks have used "forward guidance" to signal to the markets, the banks and consumers that they intend to keep interest rates low until certain economic targets are met.  This newfound transparency has also lead to investor anxiety as shown on this chart of 10 year Treasury rates:

The minute that the Fed hinted that it was even remotely considering tapering back its purchases in mid-2013, the bond market rapidly added nearly one percentage point or roughly 60 percent to 10 year yields.  This suggests that there is huge pressure looming in the world's bond markets, pressure that will be felt once central bankers decide to stop messing with the free market.

Now that we've seen the lengths that the world's key central bankers will go to in an effort to keep the world's economy from stumbling back into a very painful recession, it's time to take a look at how all of these unprecedented, experimental and rather desperate fun and games have impacted governments, banks and individuals, a subject that will be covered in Parts 2 and 3 of this posting.


  1. It appears the central banks of the world have made the crux of their existence a balancing act. You can almost imagine these bankers standing atop a fence. On one side lays a field of inflation and on the other a deep pit of deflation. A new round of easing by central banks to combat a slowdown in growth may again be in the cards but do not be surprised if this time it is less successful. The magic of this policy is losing its luster. The post below looks deeper into the dangers of this policy.

  2. Years ago before the "Bernanke has all the answers" era, many of us criticized Japan for failing to own its problems. Many people thought Japan should face up to the mess it had created and do the right thing. Broadly accepted was the concept that only by letting its zombie banks and industries fail could Japan clean out the system and move forward. While they claim otherwise, in many ways Bernanke and the Fed have put America on a path that mirrors the unsuccessful path taken by Japan. My compliments on the use of some great charts.