Opinion



October 21, 2019,   5:04 PM

To Ease Or Not To Ease

Wail Alkahtany

Wail Alkahtany is the Chief Legal Counsel at the Saudi Ministry of Finance. Articles reflect the author’s personal opinions and do not represent those of his employer or anyone else. FULL BIO

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If you have been following the news from the U.S. Federal Reserve, you might be scratching your head, wondering what are the “funding pressures” that necessitated the Fed to step in and inject liquidity into the financial system.

The liquidity shortage was not an isolated incident, the phenomena was prevalent to the point of putting interest rates at risk of spiking. So, the Fed intervened and injected cash in the system by purchasing securities (e.g. bonds and mortgage-backed securities). But what really promoted the shortage? Pundits offered several explanations, notably that companies needed to withdraw cash to pay their tax bills and this, combined with the new financial rules requiring banks to keep a certain amount of reserve, contributed to the shortage. The Fed offered billions of dollars in available funds for the upcoming months to alleviate the need for cash. So far, sounds reasonable, so why wonder?

Well for one thing tax bills shouldn’t take institutions by surprise, and certain securities that the Fed is purchasing from the banks should be considered part of its reserve. But more importantly, since the 2008 financial crisis, the Fed has pumped so much liquidity into the system some estimates put the amount in the range of $2 trillion by basically doing the same thing (Quantitative Easing, or QE).

QE halted the 2008 financial crisis by, among other things, injecting cash into the system to spur lending and investments, taking the economy out of recession and leading to growth. QE was announced to be a success and the Fed began in 2017 to reverse it (what is referred to as tapering)—basically reducing new cash that is injected in the system (but not eliminate it). So, if QE worked and there was enough liquidity in the system, how could there be a funding shortage? Also, why is the Fed insisting that what it is doing is not QE?

Current economic indicators are good from the Fed’s perspective. These mainly include unemployment and inflation, both of which show improvement. As such, the conditions for which QE was initiated are no longer prevalent and hence, why perhaps the Fed insists that what it has started doing is not QE.  

However, if we look at the GDP components growth, we see that the largest percentage of growth came from consumption and some investment except for the second quarter of this year where growth in investments was actually negative. Consistently, growth has concentrated on consumption. 

Consumption is good for inflation and it creates some job numbers but the jury is still out as to whether this could be relied upon for long-term economic growth. So far, most of the growth in non-farm job numbers came from the services sector and local government hiring. Indeed, QE seems to have worked in some sense, but not so much on exports.

It appears the QE injected funds did not create significant new exports; what it did is it increase the value of existing companies. Consumption is also fueling growth in earnings, leading to a further increase in stock values. At the same time, the global bond yield outlook is looking negative for advanced economies, which pushes demand for the U.S. dollar, making the dollar stronger and therefore creating more appetite for consumption.

The monetary policy appears to have created pockets of funding piles in the system which are not healthy to maintain, like a clogged vein asset prices are ballooning and debt is increasing. In fact, household debt has reached levels higher than during the 2008 crisis.

QE was intended to encourage businesses and individuals to borrow to create new goods and pay back their loans so that the fund cycle is self-sustaining and balanced with a strong U.S. dollar on the basis of exports. But the numbers paint a different picture. There is a dependence on cheap funds and inflation is trending upwards, and if this continues, the Fed will be hard-pressed to at least not reduce interest rates, otherwise, an important tool in its toolbox will be eliminated.  

And with the advent of the yield curve inversion predicting a recession, the Fed will need all its tools to deal with it. The U.S. and China trade war also adds to the recession risk, but it should not, on its own, disrupt the fund cycle.  

It really shouldn’t matter whether we call it QE or not, the focus should be on analyzing the need for its use and the possible consequences of that.  In any event, let us hope that this funding situation is short-lived.

 



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