QE Is Harmful. Would Doing Nothing Be Better For Markets?
QE doesn’t work, at least not in the sense of fulfilling its objectives as a policy choice.
These would be, broadly, higher economic growth, higher employment, and higher inflation (the good kind).
In short, QE is supposed to be a monetary bazooka that does magical things. Instead, it’s been more magical thinking, not doing much good, while creating serious unintended consequences and second order effects.
Would it be better for central banks to just not do anything?
Doctors have a term for this, iatrogenesis, quite possibly first introduced into the financial lexicon by Nassim Taleb in his book “The Black Swan”, which describes QE’s effects very well.
Iatrogenesis, in the medical context, simply means the causing of a disease, complication, or negative effect by any medical activity. “Any” here encompasses the full suite of actions doctors may or may not take, from diagnosis, intervening action, making mistakes, or simple negligence.
In other words, it’s about taking action and having things not work out because of that action.
It is important to note that there is often a long chain of events between action and unforeseen/undesirable consequence, where different decisions could have been made to change the course of events.
But, there are also instances where the consequences can be quickly and directly traced back to the initial action, and QE falls firmly into this category.
How?
QE actively makes the repo market unstable with all sorts of nasty, and more importantly, global, consequences.
By purchasing USTs, the Fed removes the primary form of collateral used in the repo market, which increases the probability of a collateral squeeze. Should markets be overly leveraged and overly bullish, such a squeeze has the potential to quickly snowball into mass liquidations which cascade through multiple asset classes globally.
Also, since the majority of market participants believe that QE is magical, they are predisposed to being overly bullish when a central bank announces yet another iteration of QE.
It’s almost as if policy makers want to set the system up for fragility and future failure.
Take a moment and consider the ramifications of this – that 1) Central Banks do not understand how money is created and how the financial system actually works, or 2) they do understand it but are not tailoring their policies to reality.
If 1) is true, then what good are these QE loving Central Banks doing?
If they do not understand the very basics of how the system they are overseeing works, that means that all their future monetary policies are dead on arrival, not to mention the decade(s) already gone.
On the other hand, if 2) is true, then it begs the question – Why?
A possible reason is that Central Banks feel the need to be actively doing something, which is after all a very normal emotional reaction all humans have in times of crisis.
Which brings us back to iatrogenesis.
Taking action because one feels that one needs to take action, or even worse, because one doesn’t want to be perceived as not taking action, surely counts as a poor reason for doing so.
This is especially the case when considering that QE doesn’t do much good, but still causes debilitating second order effects (e.g. reducing repo collateral).
The risk-reward of the policy is clearly off, so why persist with it?
Wouldn’t it be better for central banks to simply not do anything, at least until they figure out a course of action that is, at the very least, not harmful?
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