QE's Untold Story: A Chart That Fed Correspondents Need To Investigate
This post comes from Daniel Nevins, a Chartered Financial Analyst and economist, who discovered an interesting chart while doing research on financial flows during the Federal Reserve's quantitative easing programs. QE has been hailed by many as the savior of numerous economies since the financial crisis, however, Nevins' chart raises many questions as to what QE really does or, more importantly, what it doesn't do.
Daniel Nevins, CFA, has invested professionally for thirty years, including more than a decade at both J.P. Morgan and SEI Investments. He is perhaps best known for his behavioral economics research, which was included in the curriculum for the Chartered Financial Analyst® program and earned him recognition as one of the founders of goals-based investing. He has an economics degree from the Wharton School of Business and a degree from the University of Pennsylvania’s engineering school. He is also the author of the recently released book Economics for Independent Thinkers.
Visit Daniel's website here: nevinsresearch
We’ve produced some research over the years that we’d love to see the powers-that-be react to, but none more so than our look at financial flows during the QE programs.
By netting all lending by banks and broker-dealers and then comparing it to the Fed’s lending, we stumbled upon a chart that seemed to show exactly what QE does or doesn’t do. But what QE doesn’t do was the story, and it could not have been clearer or shown a more stimulating pattern. What we found in Excel was like stepping from a shady trail into a sunny vista.
Here’s the updated chart, which we dubbed the “argyle effect” and looks even sharper than it did when we first produced it in 2014:
Click on image to view larger version
We like the chart because we’re just as confirmation-biased as the average human—anything that confirms our QE skepticism is cognitively satisfying. And the chart appears to show that QE was largely irrelevant. It merely replaced growth in privately financed credit with growth financed by the Fed. The Fed grabbed the credit-growth baton for QE laps and returned it to the private sector for QE pauses, and whoever didn’t have the baton more or less stood still. As we concluded in 2014, QE is a substitution story, not an addition story.
Many pundits told the addition story as QE was underway. They expected banks to “multiply up” reserves by aggressively expanding their loan books. But reserves never significantly multiplied. We think there are five reasons why the “money multiplier theory” failed:
- High-quality borrowers don’t emerge mysteriously from cracks in the Eccles Building and parade zombie-like to bank loan desks. In other words, credit demand was probably about the same with or without QE.
- QE’s effects on bank balance sheets aren’t quite as distorting as they’re often depicted. Consider that new reserves are typically matched by new deposits, because dealers offering bonds to the Fed get paid for those bonds through their accounts at commercial banks. In other words, QE adds a similar item to both sides of bank balance sheets, which you might not appreciate if your information comes from those who call for banks to “lend out” reserves. That’s impossible—reserves can’t be “lent out”—and it often leads to exaggerated statements about the implications of excess reserves.
- To a significant degree, banks can neutralize excess reserves (and the corresponding “excess” deposits) with financial derivatives and other balance sheet adjustments. They can rearrange exposures to mimic a balance sheet of equal risk that’s not stuffed with reserves.
- Just as importantly, excess reserves flow naturally from banks that don’t want them to banks that don’t mind them nearly as much. Consider that Fed data shows a disproportionate amount of QE’s extra reserves landing at U.S. branches of foreign banks. Those foreign banks might have sound reasons for holding excess reserves.
- The money multiplier theory is inconsistent with real-world reserve management practices. The Bank of England has called it “reverse” to how bank lending and reserve management work in the real world. And the gap between theory and reality is so large that you don’t even need the four reasons above to reject the money multiplier—you just need a healthy skepticism about mainstream theory.
According to our chart, even QE’s wealth effects appear to be poorly understood. If credit growth is the same with or without QE, any effects on bond and stock prices might be more psychological than commonly believed. Or, those effects might transmit mainly through financial derivatives (see #3 above). Some readers may also be asking, “What wealth effects?” We’ll never know for certain if QE boosted asset prices at all. Maybe the bull market only needed low interest rates, a slowly growing economy, the knowledge that our policy honchos wanted asset prices higher, and a soothing narrative that they have the tools to make that happen.
Think of it this way: New borrowers know approximately how many calories they can consume, and after the Fed starts delivering three meals a day, private banks find that their contributions are no longer needed. By necessity, private banks shut down their kitchens, and almost nothing changes economically. We get substitution, not addition.
Getting to the Bottom of the Argyle Effect
To be sure, the argyle effect might not be surprising to the Fed’s policy makers. They might have already looked at the data in the same way we did. They might also believe that QE increased the overall lending trend (referring to the entire period’s lending growth), irrespective of the pattern from one QE to the next. All that said, we’d like to know their reaction.
We’d like to know: Would the Fed’s heads explain the chart pattern differently to our interpretation above? If our interpretation is on the central-bank-printed money, how do they justify their policies? How do they expect the pattern to change as QE unwinds?
Lastly, do they not know what to expect or are they as confused as anyone else about what QE really does? It seems like the latter is a possibility based on public statements by both current and former FOMC members. (See, for example, Bill Dudley here, Kevin Warsh here, or just about anything from Richard Fisher.)
So, we’re asking Fed correspondents to lend a hand nearly nine years after QE began. Here’s a chance to make the discussions more interesting, as inquiring minds would like some answers to the questions above.
5-year economic forecasts on 30+ economic indicators for 127 countries & 33 commodities.
Date: November 10, 2017
TagsInfographic Housing Market Banking Sector Healthcare Commodities Precious Metals Commodities Spain Investment oil prices Japan Vietnam G7 Energy Commodities Major Economies Emerging Markets Consensus Forecast IMF India Germany Canada Greece Iran precious metals Venezuela Asia OPEC Colombia Agricultural Commodities Tunisia Company News Brexit Africa Base Metals Commodities Latin America European Union Portugal UK Exchange Rate Economic Growth (GDP) Nordic Economies United Kingdom Australia TPP France Eastern Europe Gold China Inflation Russia Brazil Italy Trade Argentina Bitcoin Sub-Saharan Africa Cryptocurrency Oil South Africa Forex Unemployment rate Turkey Ukraine Mexico Euro Area USA MENA United States
7 hours ago
8 hours ago
9 hours ago
Central and Eastern Europe growth is forecast to come in at 3.9% this year. Next year, growth is projected to slow… https://t.co/D4uYgxqN8k
10 hours ago
10 hours ago
- The Story of Steel
- Latin America is the World Leader in eCommerce Growth Despite Serious Challenges
- What the TPP means for trade in Latin America
- Elections in Russia: Analysis and Implications
- 2018 & 2019 Economic Outlook for the Top Oil Producing Countries
- Nearly a Third of Latin Americans Have No Right to a Pension
- A Look at Healthcare Models Around the World
- The Poorest Countries in the World
- Newly-elected Chilean President Sebastian Piñera faces a myriad of challenges - economic and otherwise
- The Economic Effects of Trade Protectionism
- Regional Disparity: The Dark Side of Inequality in Latin America
- Coal: The story of the world's most abundant fossil fuel
- Gold: The Most Precious of Metals (Part 3)
- Venezuela's Electoral Conundrum
- Trump's 1st Year: 95 Analysts Surveyed on U.S. Economy
- The Latest on China and What's in Store for 2018
- An in-depth look at the Eurozone’s booming economy and the challenges that lurk in the shadows
- China’s growing influence on the Latin American economy
- Top Economics & Finance Blogs of 2018
- How Latin America emerged from recession in 2017
- Is this the beginning of the end for Bitcoin?
- Emerging Markets 2018 Economic Outlook
- Risks and Opportunities for 2018 - Daniel Lacalle
- The role of FDI in Vietnam’s socio-economic development
- Increasing poverty in Latin America takes a breather thanks to improving economic dynamics
- What will be the most miserable economies in 2018?
- The World's Top 10 Largest Economies
- Is Spain doing enough to address its high youth unemployment rate?
- Has Latin America gone far enough in reducing barriers to international trade?
- Commodities Outlook: Oil, Natural Gas, Coal, Lead & Tin
- 21 experts tell us what the future looks like for cryptocurrencies and blockchain
- Turkish lira plummets to all-time low on Erdogan’s monetary feud and tense U.S.-Turkey relations
- Copper: The first metal mastered by man
- Nigerian Economy Still Treading Water Thanks to Oil Sector
- The Mercosur-EU Free Trade Agreement: Obstacles & Opportunities
- Elections in Chile: What the results could mean for the economy
- QE’s Untold Story: A Chart That Fed Correspondents Need To Investigate
- Holland’s fragile one-seat majority government targets economic growth at the expense of fiscal sustainability
- South Africa: Economy at a tipping point?
- Latin American Commodities: What’s behind the increase in demand and prices?
- Is the UK really "shackled to a corpse"?
- Spain-Catalonia: 7 economic experts weigh in on how the situation will affect the outlook
- How well is Spain's labor market doing since the crisis?
- Which countries will have the highest and lowest inflation in 2017?
- How vulnerable is Latin America to economic crises today?
- Iron ore facts and common questions answered
- The bulging economic costs of obesity
- How much investment is needed to salvage Latin America’s crumbling infrastructure?
- A Look at the Potential Impact of Brexit on the Dutch Economy
- Emerging Markets Are Kicking Into Higher Gear In 2017
- Why is foreign direct investment in Latin America falling again?
- Are Central Banks Nationalising the Economy?
- Bounty or burden? The impact of refugees on European economies is far from clear
- What’s the future of U.S.-Latin America trade relations?
- Taxes or cutbacks? Latin America's challenge of sustaining spending without causing debt to skyrocket
- Are uranium prices making a comeback?
- Taxing the Economy: Achieving a Delicate Balance
- How will Latin America’s upcoming lengthy election cycle affect the reform agenda and credit ratings?
- How will emerging market economies perform in 2017?
- Chilean Economy in Focus: Interview with Senior Economist of the Chamber of Commerce of Santiago
- CEOs Rank Top Economies for Growth Opportunities
- The Mobile Ecosystem & Latin America's Economy
- Prospects and Challenges for the Global Economy: Interview with Tim Cooper from BMI Research
- How will the Fed reduce its balance sheet & and how will the ECB end QE? - 19 economic experts weigh in
- Thoughts on "unwinding" QE from Frances Coppola
- The Fed and ECB at a crossroads: Unwinding QE
- Spain: The economy that continues to silence the critics
- Latin America: The Most Unequal Region in the World
- The History of OPEC: Has it been a Success?
- FocusEconomics Announces 2017 Analyst Forecast Awards Winners
- Latin America’s rising unemployment bucks nearly decade long trend
- Escape from the Central Bank Trap by Daniel Lacalle
- China's economic rebalancing act: What to look out for in 2017
- Driving Growth in Latin America: Challenges & Priorities
- Is the Global Economy Rebalancing?
- Commodity exporters face challenging times
- Recent Global Events Facilitate Mercosur-Pacific Alliance
- 23 economic experts weigh in: Why is productivity growth so low?
- Mexico's outlook as Trump nears 100-day mark
- Interview with Oxford Economics Senior Economist on implications of the possible outcomes of the French Presidential Election
- The anxiety of the small saver in a world of negative interest rates
- Brexit negotiations. Between Uncertainty and Urgency
- An Economic History of the EU from El Blog Salmón
- Baby Boomin': Implications of high population growth in Latin America
- Survey of International Economists Predicts a Le Pen Defeat in French Elections, Says Macron has Best Economic Plan
- Spain in a global context: developed economy with some challenges
- How much is crime costing Latin America?
- Predictions & Estimates from Economist Daniel Lacalle
- What economy will the new Dutch government inherit?
- “The data is not a true reflection of reality in India” Interview with Société Générale India Economist
- What are the prospects for Emerging Economies in 2017?
- What to expect in Asia for 2017
- Top Economics & Finance Blogs of 2017
- Latam to Resume Moderate Growth in 2017 but Important Risks Plague Outlook
- 4 Key European Elections That Will Impact the Economy in 2017
- How are security concerns and political chaos affecting Turkey’s economy?
- Global growth to edge up in 2017
- Set to breach targets again? Debt and deficit outlooks for Southern European Eurozone countries in 2016 & 2017
- What does Donald Trump mean for the U.S. economy?
- How will emerging markets perform in 2017?
- The economic impact of a break in U.S.-Philippines ties
- Trump election: Base metals surge due to infrastructure plan
- 5 updates on the Venezuelan economic crisis
- Canada: When your neighbor’s house is on fire…
- Short-term pain before long-term gain? A look at French labor reform and economic growth
- Asia: Unremarkable growth & unfulfilled promises?
- How India's latest monsoon is affecting the economy
- Innovation in Latin America: Potential Goes Untapped Due to Weak Economic Conditions
- Russian economy update in wake of OPEC deal announcement
- The Wisdom of the Crowds and the Consensus Forecast
- Can the peso predict the U.S. election results?
- There's no end in sight to the Venezuela crisis
- A Look at the European Union Political Calendar
- Survey of international economists shows uncertainty surrounding elections damaging U.S. growth prospects
- FocusEconomics partners with leading online statistics provider Statista
- China: Recent postive economic data may be papering over the cracks
- Sub-Saharan Africa's 2016 & 2017 growth rates
- The Italian Dilemma: Weak banks pose risk to already faltering domestic demand
- How much money do migrants from Latin America send home?
- The U.S.' (Not So) Mysterious Case of the Missing Men
- What to expect from the G20 economies by 2020
- The Pain in Spain: Robust GDP growth cannot mask the persistent structural deficit