Struck down by a covert QE

Global sharemarkets were hit hard overnight as investors began to lose confidence that the US central bank would soon embark on another bout of bond buying in an attempt to spur economic activity.

Minutes from the March 13 meeting of the US Fed's policymaking committee, which were released overnight, appeared to indicate that the US central bank had no plans to launch a new bond buying program – known as quantitative easing.

Highly regarded US economist Lacy Hunt, who is executive vice president of Hoisington Investment Management, which has $US5.6 billion in assets under management, argues that the US central bank is now wary of launching a new quantitative easing program – already dubbed QE3 by the markets – because it is increasingly aware of the negative consequences of its previous QE strategies.

In an interview with Business Spectator, Hunt, who was previously the senior economist for the Federal Reserve Bank of Dallas and the chief US economist for HSBC, argues that we've not only had QE1 and QE2, but that there was an additional stealth QE in early December last year. He points out that at one point the US central bank expanded its balance sheet by $105 billion in order to make loans to the European Central Bank. Although this stealth QE wasn't as large as QE1 and QE2, it was still a very sizeable amount.

According to Hunt, QE programs always follow a similar pattern. "Whenever the US Fed engages in radical balance sheet expansion, an initial liquidity effect on markets is evident. Domestic and global stocks rise. But also some of this liquidity goes into commodities, because the Fed has no control over the process once the balance sheet has been expanded.”

He says that as a result of QE2, and the stealth QE since early December, "wholesale gasoline prices have risen by more than the increase in domestic or global stocks, and big increases occurred in other commodities that are important elements in the cost of living.”

"So the Fed, through QE1 and 2, and the recent stealth QE, has increased the inflation rate, at least temporarily. It's now at 3 per cent. At the same time, wages are continuing to decline in real terms. Year on year, wages only rose 1.9 per cent in nominal dollars. Thus, the Fed undermined the living standards of millions of modest and medium households.”

He adds that "in the twelve-month periods ending in February 2012, real disposable income per capita dropped 0.4 per cent, but in the latest three months, the annualised rate of decline was a sharper 0.7 per cent. In essence, through its policies, the US central bank exacerbated the income and wealth divide. The high end benefited from higher stock prices while the broad middle worsened.”

But according to Hunt, the US central bank is now more wary of embarking on future quantitative easing. One possibility that has been raised is that the Fed might borrow funds from the marketplace in order to fund additional bond purchases. Because the actual size of the US central bank's balance sheet would not increase, there would not be a lift in share and commodity prices.

"I think they're now aware that balance sheet expansion has had counter-productive effects, and so they may be more interested in a sterilised approach. And this different approach is not going to produce the short-term liquidity and inflation effect that was evident in QE1 and QE2, and the stealth QE.”