The famous saying ‘if the US sneezes the world catches a cold’ has probably held true for several decades. However, everything has its sunset, and I believe that the time has come for this phrase to be shelved.
The saying’s bane will come as a surprise to many as it will not be emerging powerhouse China, the European Union or global economic integration that kills the saying, it will be quantitative easing. From now onwards, when any country sneezes a shot of QE will do the job.
QE has become the antibiotic of the finance world. Whether there is global economic growth, a US recovery, Chinese expansion or fiscal integration; the ultimate answer is not ‘42’ it is QE.
What many do not realize is that QE is an experiment that is still ongoing. Let take the US; previous Fed Chairman Ben Bernanke, known to be an expert on the Great Depression, initiated an asset purchasing program known as QE1 in November 2008. The third round of the program, QE3, ended in October 2014 after a period of ‘tapering’.
A final phase would require the reversal of the program, however, this is unthinkable when doubts still exist on the health of the US economy. Thus it is impossible to make any judgment at this stage. Furthermore, from an academic point of view, it will probably take decades before the current QE ‘craze’ can be evaluated.
What is immediately evident to any basic economics student is that the impact monetary policy in isolation is limited. The limitation is more pronounced if expansionary monetary policy is intended as a countermeasure to fiscal inefficiency.
Take the Euro Area; the Euro Area began its QE program in March 2015. The stimulus is planned to last until September 2016 at its earliest. From the onset it is evident that the success of the ‘European experiment’ would depend on fiscal reform, especially in southern European countries.
Unfortunately fiscal reform in the Euro region to date has been slow at best. There is also skepticism about any significant reform from Italy and Greece. Spain appears to be moving in the right direction, however, recent regional elections indicate that there may be a change in political direction.
France has maintained its left-leaning bias throughout the crisis thus capping its economy’s growth potential. Germany remains Europe’s success story. However, QE for Germany makes little sense as it is already speeding at full throttle.
In this scenario, from an investment point of view it is best to hedge against the implicit effect of QE. QE suppresses interest rate, devaluates exchange rates and leads to inflation. Inflation and low interest rates will likely impinge in savings and purchasing power. In addition, while fiscal reform is in doubt, banks continuing to hoard domestic sovereign bonds yielding close to zero. However, all the money created has to end up somewhere.
In the short-term, the bulk will probably be directed towards the equity market. Equities have already outperformed in this environment and are expected to continue to perform. Equities are also an efficient inflation hedge as revenues and earnings typically increase with inflation. Since European equities are the best positioned to gain from the low interest rate, weak exchange rate and cash rich scenario created by quantitative easing, it may be best to join the club.
This article was issued by Antoine Briffa, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.
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