What will the post-QE world look like?

It helped shore up the balance sheets of both the big banks and the US government. At the same time, interest rates have been brought down to near zero. But the side effect has been speculative financial bubbles and a widening income gap. The markets have become used to the “easy money” of QE and are now nervous at the prospect of its impending withdrawal.

Simply put, QE has been the prime mover in the stock market since 2008. Stocks have rallied to all-time highs because banks and funds with access to QE’s easy money have used the proceeds to drive up equity prices. Yet the economic fundamentals have not changed at all. The US is still suffering from a structural problem of indebtedness. The US Social Security Administration reports that the average yearly salary of Americans now stands at $44,888.16. At that level, it would take Americans 398 million years to work off the US government debt, of $17.9 trillion. But if unfunded liabilities of $116.2 trillion are also taken into account, it would take 2.38 billion work years to pay off the debt.

This is the structural problem that stands in the way of a US economic recovery. Without dealing with this obstacle, the US will forever be drowning in a sea of debt. Yet instead of biting the bullet, the US chose the easier but disastrous path of embarking on QE.

“To be clear QE 1 and QE 2 were widely accepted in the business community because of their context: QE 1 was a reaction to the 2008 meltdown, with QE 2 considered to be needed because QE 1 didn’t quite ‘get the job done’,” notes Phoenix Capital Research in its report this month.

“However, QE 3 and QE 4 were both game changers. The first two QE programmes had fixed deadlines which emphasised the notion that eventually the Fed would end its QE efforts and risk would be permitted to move back to more market-based levels.

“However, this all changed in the period from September 2012- December 2012 when the Fed announced QE 3 and QE 4, two “open-ended” programmes without fixed deadlines.

“The message was now clear: risk would be mispriced ad infinitum until something breaks.

“It is not coincidental that the market staged its largest, most bubblish move during these programmes.

“Which brings us to today. QE 3 and QE 4 are ending in a little over a week. And the Fed has made it clear that a stock market correction will not goad it into engaging another QE programme anytime soon.”

In the absence of another round of QE, the markets are sure to crash. Economic collapse will follow. Risks are high in the financial market bubbles. The Fed is likely to be blamed for the coming crisis, and politically it will be difficult to resume QE. The Fed has fired off all its ammunition. Turning once again to QE again would amount to admitting that the markets must remain on life-support for ever. However, John Williams, president of the Federal Reserve Bank of San Francisco, said recently that QE might make a comeback if inflation falls below the Fed’s targets. He added that the European downturn and other global economic woes might pose a threat to US economic recovery.

“If we really get a sustained, disinflationary forecast ... then I think moving back to additional asset purchases in a situation like that should be something we should seriously consider,” Williams said in an interview with Reuters.

In short, the Fed has left the door wide open for a resumption of QE. Any excuses can be raised to restart QE in the event of a stock market crash or US downturn. The question is whether the Fed has the room on its balance sheet to do so. Before the 2008 crisis, that balance sheet stood at $800 billion. Now, after six years of QE and buying up mortgage-backed securities and US treasuries, that figure has swollen to $4.5 trillion. In market-to-market terms, the Fed would be declared bankrupt with these assets. Now if a new crisis arises, the Fed would not be in a position to leverage its balance sheet by printing another $4 trillion-$5 trillion. All its credibility would have gone down the tube. 

This leaves us with a dangerous geopolitical game concerning crises over nuclear-armed foe Russia, Ebola and ISIS, seemingly manufactured to conceal the impending structural collapse of a debt-ridden US and QE ad infinitum.