The QE deflation puzzle
James Saft on central bank bond buying, technology IPOs and fleeting stimulus.
When it comes to creating inflation, bond buying by central banks may actually ultimately be counterproductive.
Called quantitative easing, it continues to be a mainstay of the policy reaction to the ongoing economic malaise. Yet here we are five years later and the evidence that QE can kindle inflation, much less revive the economy, is decidedly mixed.
In part that may be because everyone realizes that QE isn’t forever: ultimately the bonds the bank buys will have to be repaid. It is also true - and here we can consider the remarkable valuations of Twitter and Pinterest – that QE causes bad investments, which ultimately must be deflationary.
With US inflation rising just 1.2% year on year in September, well below the Fed’s 2.0% target, bond buying by the Federal Reserve will continue – a bit like the old joke about beatings carrying on until morale improves.
Very radical increases in bond buying in Japan under Abenomics - more or less a pledge to buy and buy assets until inflation reaches 2 percent – has also had only mixed success so far, with core inflation flat in the year to September. That this, the first time Japan core inflation hasn’t fallen outright since the end of 2008, is seen as a victory is itself a bit of an indictment of extraordinary monetary policy.
Think of all the rotting houses in Florida during the crash, or the empty cities of dusty apartments and stores in China (which themselves are arguably the fruit of QE).
Dangerously falling inflation in the euro zone has prompted calls for the ECB to join in the bond buying, despite its signal lack of success elsewhere. The ECB is arguably already engaging in QE as its program of providing long-term financing to banks often leads to banks buying government bonds themselves.
So, QE everywhere, and everywhere unsatisfactory inflation and at least the threat of falling prices. Could there be a relationship? Part of the failure of QE may be explained by the fact that as a percent of broader money supply the amounts involved are small. Banks must lend and businesses invest or QE will be swamped.
In some ways, all of the inflationary effects of QE are short-lasting and liable to reversed. Not only is everyone involved aware that ultimately the bonds are not being bought and burned, but bought and held, and thus must be repaid or will be sold by central banks.
Also, QE encourages private investors to gamble a bit, perhaps leading to poor choices.
“Unproductive investment is by nature ultimately deflationary,” Michaela Marcussen, global head of economics at Societe Generale, wrote in a note to clients. “This is a point also worth recalling when investing in paper assets fueled by QE liquidity and not underpinned by sustainable economic growth.”
Technology IPO boom
And this brings us to the quite remarkable boom in initial public offerings, particularly in technology.
Twitter, that 160-character microblogging wonder, raised the top end of its IPO price range by 25 percent on Monday. The company, whose offering will price on Wednesday, may end up being valued at almost $14 billion, or about 13 times revenue. Not 13 times earnings, but 13 times revenue.
For comparison, Boeing, which makes airplanes rather than selling ads against tweets, fetches a bit more than one times sales. Microsoft goes for about 3.5 times sales.
Pinterest, an Internet service which allows users to post pictures and other media, raised $225 million recently in a private deal placing a $3.8 billion value on the company. That’s $158 for each of its 24.9 million users. I can’t give you a price-to-revenues figure because Pinterest has never reported revenues and very well may not have any.
Now clearly Pinterest and Twitter are growth companies, and may well amply repay their investors with future actual profit derived from future honest-to-God revenue. But there can be no guarantees.
Things feel a bit bubbly and the problem with bubbles is at least two-fold. In a bubble, people build and invest in things which aren’t themselves needed and ultimately don’t create genuine revenue and growth. Think of all the rotting houses in Florida during the crash, or the empty cities of dusty apartments and stores in China (which themselves are arguably the fruit of QE).
Those investments were stimulative for a while, but ultimately highly deflationary.
In different ways, though by different paths, the same thing may prove to be true about investments made now during the time of QE.
All debts ultimately must be repaid, defaulted upon or forgiven. Not much progress has been made on any of those three scores.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at email@example.com)