Wednesday, September 28, 2016

Why is QE — ZIRP/NIRP not working?

Most people wonder as to why Quantitative Easing (QE) along with low interest rate policy is not making their life easier. John Mauldin and Neil Jensen in their letters are wondering where the road to recovery is? Where is the inflation? Where are the corporate profits? Where is the growth? QE and low interest rate policy were the response of FED to the crisis of 2008. Some central banks have already gone Negative interest rate policy. But as yet, they are not working. Why? Because they are not supposed to work.

The crisis of 2008 was the result of few forces striking together — an over leveraged borrower, inflated prices of collateral and banking system with management’s hand in the cookie jar (lower provisioning and accounting gimmicks to announce record profits), resultant working capital -denied supplier and a proprietary money-desk betting on failure of the main street engineered by bank runs. When the crisis unfolded the prop-bets made a X amount of money, main-streets bets lost a 10X amount of money and banks ended up in trouble. FED’s response — lowering interest rates and priming the pump through QE was designed to recapitalize the banks and not rebalance the economy. When viewed through this lens the action of the FED makes more sense.

With low-yield funds from the FED, banks bet in the markets and earn capital gains to buffer their balance-sheets. With the balance-sheets bolstered with excess capital, the banks may, if they take fancy to it, then start lending to the main street thereby kickstarting the main-street which will hire more, jobs will come back, incomes will rise and debt will be repaid and world will be glorious once again.

This lens also tells us that FED is not going to raise interest rates any time soon. Not yet. The reason is that banking system is ever more skewed. The banks figured out way to make money for the management and shareholders without going through all that trouble. Just bet on the markets — inflate the asset prices (we are at upper end of the PE multiple band for stocks, Housing prices are recovering when quality of jobs is declining) make the bets, earn the money, keep provisioning low but DON’T announce record result as some costs have gone up. If you are wondering which costs are going up when inflation seems to have losts its mojo — don’t ask me. “The math dont add up mate!” Since provisioning is not adequate, if asset prices were to correct, banks will be in ever more trouble. The “Too big to fail” have become “If I fail you really get fucked” big. They need high asset prices and INCREASING asset prices to justify and unwind this shit.

Oh and if you want a way to fix the banking for real — fix the main street and banks will fix themselves.