Five years on, QE is just not working... - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Five years on, QE is just not working... 

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In this issue:
» India's CAD is the worst among peers
» Is BRICS losing relevance?
» US shutdown could lead to debt default
» Will food security bill distort world trade?
» ...and more!

The US and the rest of the developed world was a whole lot different in the years just before the 2008 global crisis. It was a consumer driven culture with the governments encouraging not just spending but also borrowing to consume more. What happened after that is history. But the central banks in these countries chose not to learn a lesson. In a state of frenzy that continues even today, they unleashed a whole lot of money into the financial system. This is otherwise known as quantitative easing. Their rationale was that more money into the hands of the people would encourage them to spend more. And an increase in consumption would kick start their economies which had sunk into recession. The fact that such indiscriminate spending led to the crisis in the first place was conveniently forgotten. So have the central banks in the US, Europe or for that matter Japan achieved their objectives?

The facts tell a different story. As per an article in Moneynews, 5 years after the collapse of Lehman Brothers, families in these developed nations are so scarred from the crisis that many of them are fiercely holding on to their cash. Some of these statistics speak for themselves. Take debt for instance. Before the crisis, household debt in the 10 countries jumped 34%. Five years since, debt per adult in the 10 countries fell 1%. This is despite the fact that lending rates had reached record lows. Indeed, before the crisis, such cheap lending rates would have led to a surge in borrowing.

That is not all. Spending has also reduced as people have chosen to conserve cash and pare debt. Adjusting for inflation, global consumer spending rose 1.6% a year during the five years after the crisis. That was about half the growth rate before the crisis.

Cash holdings tell a similar story. Households in the six biggest developed economies added US$ 3.3 trillion, or 15%, to their cash holdings in the five years after the crisis. This is slightly more than they did in the five years before. What is interesting is that this rise in cash has come at a time when unemployment has risen, wages have shrunk and debt has been repaid.

All these figures very clearly point to the fact that the monetary policies of the US Fed and all other central banks of the rich world for that matter are flawed. But the money printing exercise still continues. There is obviously a lack of faith in the governments to bring about a turnaround in their respective economies. Unless the government does something meaningful to restore confidence, no amount of QE is going to induce people to spend more. The sooner the central banks realise this, the better off the global economy will be.

Do you think that the central banks of the world will realise the futility of quantitative easing measures and put an end to the same? Let us know your comments or post them on our Facebook page / Google+ page

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01:26  Chart of the day
Rising current account deficit (CAD) has become a chief headache for India in recent times. Indeed, rise in imports, falling exports and decline in the rupee have only made matters worse. So, it is hardly surprisingly that when compared to its peers, India's fared the worse as far as CAD is concerned in the second quarter of 2013. So far, the government has been focusing on short term measures such as placing curbs on gold imports and the like to prevent the gap from widening. But this is hardly going to help from a longer term perspective. For that, the focus will have to be on making exports more competitive and making the country more self reliant as far as energy needs are concerned.

India has the worst current account balance
Data Source: The Economist

Government funding has been the lifeline for PSU banks over the last 5 years. Ever since the banks started providing for pension dues and restructured assets, capital constraints have hit hard. Hence, notwithstanding fiscal pressures, consecutive budgets have enhanced the provision for capital infusion in PSU banks. It may be recalled that in the Budget for 2013-14, a sum of Rs. 140 bn was provided for this. This amount is meant to not just help banks brace with capital pressures in the wake of Basel III norms. But also help tide over the pressure on balance sheets due to the wave of slippage on restructured assets.

We believe that the move will hardly help improve the financial condition of these banks. For the mandate of the government is to offer cheaper rate loans for two wheelers and consumer durables. The trade off may not prove to be fruitful for banks already struggling with high NPAs. Further, we do not think such measures would revive consumer demand and in turn economic growth. The taxpayers' money, meanwhile, continues to be used to fund inefficient PSU banks to follow the government's socialist mandates.

If BRICS stood for the most attractive emerging markets any idea what BIITS stands for? Well, as per a leading daily, this acronym stands for the most vulnerable emerging markets. Ironically, India finds a mention in both of these. In fact, BRICS has lost its relevance in the current environment. And thus it would be fair to call India more vulnerable than promising as per the article. Certainly, India's vulnerability has been a hot topic for quite some time now. Therefore, finding India vulnerable is not a particularly new insight. What's essential is how we come out of the mess we frequently find ourselves in. Clearly, our biggest problem is our twin deficits. And unless we bring about a structural change in the same, there's going to be no respite we believe. So while for the time being we occupy a sorry place in BIITS, a couple of big bang reforms and we could well be in the group of most promising emerging nations again.

Government debt is generally risk free. There are no chances of default as the government just has to print the money to honor its obligations. However, US shutdown has raised concerns over the country defaulting on its debt. The impasse between the two political parties in US has delayed the resolution to increase the debt ceiling of the government. If there is no consensus by October 17, then US treasury will find itself in a precarious situation. Its cash levels would deplete by then and thus honoring payments can get difficult.

However, the likelihood of default is very low as government understands the repercussions on a nation's rating of a default on public debt. But the fact is that the US government will have only US$ 30 bn in cash once it runs out of its borrowing capacity by 17th October. It is believed that the government will reach a consensus by then. But it also appears that the house is committed to not allow passing a clean debt limit. This will give a leeway to the government to pile debt. Thus, the increase in debt ceiling is likely to be bundled with certain provisions. While this may curtail reckless borrowing the fact is that US is already muddled in debt. Any increase in borrowings from here on is likely to make the matters worse.

On several occasions, we have expressed our disappointment for the UPA government's Food Security Bill. The food security programme will cover two-thirds of India's 1.2 bn population. The financial implications on the government budget are set to be huge. But the impact of this law will not be limited to India alone.

While the UPA won the domestic battle by taking the ordinance route for the ambitious Bill, it's not all over yet. As an article in Business Standard reports, India now needs to assure global negotiators, mainly the US that this law will not have 'market distorting' repercussions on trade. As per Agreement on Agriculture (AoA) India and other developing countries are restricted from exceeding 'market distorting subsidies' to farmers beyond 10% of total production. With the food security programme, India is set to breach this restriction. So India will have to fight at the World Trade Organization (WTO) for its right to subsidise.

What becomes of this issue remains to be seen. But one thing is clear. The food security programme will weigh very heavily on government finances. The ghost of the fiscal deficit will come again to haunt Indian policymakers and hurt an already ailing domestic economy.

In the meanwhile, the BSE-Sensex was trading higher by about 90 points or 0.5%. Barring stocks from the information technology and metal spaces, gains were seen across the board with engineering and banking stocks being the top performers. Midcaps and smallcaps were trading firm as well with the BSE-Midcap and BSE-Smallcap indices up by about 0.3% and 0.4% respectively. Stock markets in other parts of Asia were trading positive with Japan, China and Hong Kong trading higher by 0.3%, 1.1% and 0.7% respectively.

04:56  Today's investing mantra
"I have owned one stock since 1969, two since 1988 and one I started buying in 1986 or so. That's my portfolio. Six stocks. I once owned 17, but that was way too much."- Philip Fisher
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7 Responses to "Five years on, QE is just not working..."

Kirandeep Atwal

Oct 9, 2013

Fed in USA inhabited the invisible hand (mentioned in wealth of nation book) to work. They have saved lot of banks who are not good at risk management. They tried to help big car companies, who hire PhDs in finance but do not know how to make a car, to stay in business by reducing interest rates. If fed would have kept interest rates high then lot of non productive companies might have gone bankrupt and ultimately sold to companies with excellent management. In this way capital would have allocated to most productive use.

Same thing is happening in India too. Lot of PSU banks have made imprudent loans to ultra rich people (net worth more than 1000 crore) who have political connections. Now these people are defaulting on their loans. Guess what, government is recapitalizing these sick banks. This will increase fiscal deficit and crowd out productive investments. Moreover, defaulter of these loans is living royal life. There people have houses like palace with 30-40 servants and maintains 15-20 imported cars. These people have very high respect in society. Now, new cottage industry for agents for PSU banks has emerged. These people will use their political capital to get you the loan and they will get cut in loan amount.


Dr. Arun Draviam

Oct 9, 2013

Spending should be with in one's means. People should not be encouraged to spend more for the sake of spending. Consumption should go up; along with that savings too should go up. Without savings there will not be capital formation for investment into productive ventures. The problem with the West is: not working to earn and with that earning spending as well as saving. The culture has been one of using the plastic money (credit cards) more liberally, without bothering about the means to repay the credit availed. Thus US fostered the NINJAS culture and others have just aped. Frugality is a virtue every household should learn while working to earn.



Oct 9, 2013

The regularity in which the financial scams are coming it is doubtful that the central bank policy makers are realizing their faulty policies. They seems to be living in Mars and not in the Earth. Their are blind to the earthly realities. Otherwise how can the gap between any two scams start reducing instead of increasing. We need to regulate the contents taught in the today's management schools. It has become fancy to give new terminologies for new things no one understand and the underlying things is only greed.


Umesh Sharma

Oct 8, 2013

The CAD problem India faces is of its own making.If we are prudent in weighing the pros and cons of all the macro level trades and take hard nosed decisions there is no reason we should face CAD problems.But we do things in excess and sometimes in a total disregard of the consequences.That is how we have managed to reverse what would have been a comfortable position from CAD po int of view.If we see the capital goods imports which have affected our outgo of dollars substantially without really adding to our GDP growth The point will be clear.


Kuldeep Gadhvi

Oct 8, 2013

QE in my view is something like having a 'money tree' planted in your premises, all you have to do is pluck the currency leaves as and when you need, and because it's an effortless earning there is no need to worry about anything else, but in real life there are no such money trees. Such absolutely free printed monies by ways of QE will have serious adverse effects in long term.

All of us talk and discuss about 'Money', so what actually is this 'Money'? The shortest and sweetest conviction is to simply believe that money is money !! The currency notes we own is money, the bank balance we have is money etc etc.. but the reality is quite contrary. The currency note is a cheque that any govt gives you without printing your name on it, and also there is no expiry date on it, you get your cheques and then give a few cheques to somebody, this somebody gives his cheques to others, and that others to more others, on and on and on it goes on and eventually such nameless dateless cheques keep on circulating in this world for ages. The Govt knows that this cheques are not going to come to back to them for clearing or any exchange and it will keep rotating within this world endlessly so there is no question of dishonoring this instrument.

However, when a country and it's govt start taking this blank cheques as an instrument to fool the masses then someday, I think someday people lose faith in the authenticity and worth of this cheques, and then the turmoil follows as per the laws of economics.


krishna Murthy

Oct 8, 2013

By the time common man come to know that India is in a sorry state of economic affairs, the election will be over and the same bandicoots rule for another century with out any penalty or shame.

Like (1)

Nadir Godrej

Oct 8, 2013

The critics keep saying that QE has not worked but the US economy has revived even if it is a jobless recovery. The critic's point that QE would cause inflation has been totally disproved but they still keep up ther silly criticism.Perhaps we have not had enough QE. Certainly we have not had too much.
Kudos to Ben Bernanke. Don't believe discredited monetarists. When unemployment is high money supply does not cause inflation. Unenlightened criticism of QE reduces confidence and might explain some of the slow growth.

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