QE practical consequence?

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Sinsji
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QE practical consequence?

Post by Sinsji » Thu Aug 22, 2019 3:15 pm

Another post suggested short term TIPS and commodities as the best protection against unexpected inflation. This made me curious about QE and the implications for individual investors.

What is the difference between:

1) Quantitative easing: Central Banks buy assets from financial institutions and return (print) cash to supply the financial markets instead. While the central banks keep buying, the interest rate drops. Now in some countries cash savings at the bank lose value, as interest is raised over deposited money.

2) "Regular" inflation.

It appears to me that in both situations cash is losing value, unless any future deflation outweighs the cost of interest on cash deposits?

If QE erodes the value of cash, than (as demonstrated) money goes in to all sorts of (not-liquid) assets. I can't imagine this going on forever :?

I'm asking as I don't understand and maybe it is a stupid question, but I'd like to learn about it for my own savings.
Last edited by Sinsji on Tue Dec 03, 2019 5:21 am, edited 1 time in total.

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nedsaid
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Re: Practical difference: negative interest vs inflation?

Post by nedsaid » Tue Aug 27, 2019 11:21 pm

Your question is actually a very good one.

My recollection might be a bit foggy but I do remember that Bill Bernstein wrote that bonds lost about 50% of their purchasing power from about 1946-1982 or so. Don't have the time periods exactly right but close enough.

A big reason for this was that the US Government held interest rates artificially low, below the rate of inflation, in the period right after World War II. I heard a couple of stories of people who bought War Bonds during WWII which lost about 1/2 of their purchasing power. You could consider this a soft default on the US Debt, where instead of defaulting on payments, we just inflated our way out of debt. Strong economic growth during the post-war era didn't hurt either. So we both grew and inflated our way out of our war debts as the national debt became a smaller and smaller percentage of Gross National Product.

The Stagflation of the 1970s, a combination of a relatively stagnant economy coupled with higher rates of inflation was hard on both stocks and bonds. The oil shocks of 1973 were a big reason for the Stagflation. Unexpected inflation is a big enemy of bonds.

As far as Europe, my guess is that inflation rates are very low, policy makers there are probably concerned about deflation. We never really got deflation here in the United States after the 2008-2009 financial crisis but we certainly got whiffs of it. One reason Ben Bernanke was figuratively dropping money out of helicopters with such things as Quantitative Easing.

Valuethinker loves to post on these type of topics. Perhaps you could send him a personal message and ask him to post here. Not sure of his background but he is one of our most knowledgeable posters, he has an excellent grasp of economic history.
A fool and his money are good for business.

not4me
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Re: Practical difference: negative interest vs inflation?

Post by not4me » Wed Aug 28, 2019 3:13 pm

Sinsji wrote:
Thu Aug 22, 2019 3:15 pm

What is the difference between:


I'm asking as I don't understand and maybe it is a stupid question, but I'd like to learn about it for my own savings.
Not a stupid question at all -- but it is fairly complex. As much as anything, I'm posting to bump the thread. Would also suggest you edit the title since it mentions negative rates instead of QE. I'll throw out a few things for others to shoot at.

I've seen "QE" used as a term that applies to multiple forms of central bank intervention; I'm assuming you are using it that way & not a more precise, narrow look. I think of QE (&/or central bank intervention tools like QE) as intended to increase the money supply with hopes that will bring rates down and stimulate business by making it cheaper to borrow. So, cash is diluted by increasing the supply (in advance of increasing demand). This isn't so much market driven & perhaps demand picks up & affect on cash isn't permanent.

Not sure what is "regular" inflation. Government measures many forms; for this, I'd say think about two kinds: wage & commodity. Wage inflation might mean tight labor markets, salaries going up, businesses increasing prices to pay those salaries, people having more $ to spend, etc. Dollar doesn't go as far. Or, with commodity inflation, maybe price of oil spikes up & input cost for business (other than labor) go up. Transportation cost go up, businesses raise prices to cover. Dollar may not go as far, but consumers haven't gotten a raise to spend...

These scenarios are hopefully spurring you to think about impact outside of cash & see different causes, perhaps different reactions needed by investor.

Keep asking the questions -- no doubt others have the same & none of us have all the answers

kdsunday
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Re: Practical difference: negative interest vs inflation?

Post by kdsunday » Wed Aug 28, 2019 3:27 pm

There's been a lot of misunderstanding of QE. There is no money printing. Correctly understood, QE is the Federal Reserve implementing a change in the composition of private sector assets, effectively reducing the duration of liabilities (swapping short-term Treasuries with the overnight reserve deposits held by private banks). The thought is that private banks with a stronger balance sheet are more likely to lend or that with fewer bonds in the market, people will be more inclined to borrow and spend instead of hold bonds. It is not an inflationary event as it does not change the amount of cash in circulation, only the interest rate on some debt bearing instruments.
In theory, there's no difference between theory and practice. In practice, there is. -Yogi Berra

jdilla1107
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Re: Practical difference: negative interest vs inflation?

Post by jdilla1107 » Wed Aug 28, 2019 3:35 pm

kdsunday wrote:
Wed Aug 28, 2019 3:27 pm
There's been a lot of misunderstanding of QE. There is no money printing. Correctly understood, QE is the Federal Reserve implementing a change in the composition of private sector assets, effectively reducing the duration of liabilities (swapping short-term Treasuries with the overnight reserve deposits held by private banks). The thought is that private banks with a stronger balance sheet are more likely to lend or that with fewer bonds in the market, people will be more inclined to borrow and spend instead of hold bonds. It is not an inflationary event as it does not change the amount of cash in circulation, only the interest rate on some debt bearing instruments.
I don't agree with this at all. While there is no literal printing of currency notes, money supply is being created out of thin air. QE is also inflationary as much as "printing money" would be. But, the only reason that we are not "printing money" is because money is mostly digital today.

Here is the investopedia definition of QE:

"Quantitative easing is an unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to increase the money supply and encourage lending and investment... Quantitative easing increases the money supply by purchasing assets with newly created bank reserves in order to provide banks with more liquidity."

When people say that QE is the FED "printing money", they usually understand that money today is digital and does not involve very many actual printers. But, it is perfectly fine to say that the FED is "printing money", in my book, because it's the digital version of doing so.

jdilla1107
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Re: Practical difference: negative interest vs inflation?

Post by jdilla1107 » Wed Aug 28, 2019 3:42 pm

Sinsji wrote:
Thu Aug 22, 2019 3:15 pm
If QE erodes the value of cash, than (as demonstrated) money goes in to all sorts of (not-liquid) assets. I can't imagine this going on forever :?
QE only erodes the value of cash if it causes inflation. Consider that without QE, inflation might be -10% and QE could cause inflation to end up being 0%.

QE was created to avoid deflation. The Great Depression was a severely deflationary time which caused a lot of the havoc. Deflation can be as disastrous as inflation. Price stability is the most important aspect of a healthy economy. (not just avoiding inflation)

A lot of people here worry about inflation, because the 1970s were more recent than the 1920s. If the year was 1930, we would likely all be a lot more concerned with deflation.

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JoMoney
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Re: Practical difference: negative interest vs inflation?

Post by JoMoney » Wed Aug 28, 2019 8:08 pm

The interest rate you're offered is known and promised for some forward looking time period.
Inflation is unknown, and measured over some past time period.

It's entirely possible to have negative interest rates but a positive 'real return' if deflation occurred at a rate higher than the negative nominal interest rate.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Oicuryy
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Re: Practical difference: negative interest vs inflation?

Post by Oicuryy » Wed Aug 28, 2019 10:07 pm

Sinsji wrote:
Thu Aug 22, 2019 3:15 pm
It appears to me that in both situations cash is losing value, unless any future deflation outweighs the cost of interest on cash deposits?
The value of a cash holding equals the number of dollars held times the value of one dollar. With inflation/positive rates a cash holding will lose value unless the number of dollars increases faster than the value of one dollar decreases. With deflation/negative rates a cash holding will lose value unless the number of dollars decreases slower than the value of one dollar increases.

Ron
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Phineas J. Whoopee
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Re: Practical difference: negative interest vs inflation?

Post by Phineas J. Whoopee » Thu Aug 29, 2019 2:26 pm

If I may, Quantitative Easing increases bank reserves. The new reserves don't circulate directly, but increase the amount banks can lend, should they choose to. When banks lend money they create a debt and an offsetting bank deposit. They are of equal amount but opposite direction, which means net financial assets across the economy are unchanged. As the borrower repays principal the money the bank created is destroyed. Banks writing off bad debt also destroys the money they created.

Today there isn't nearly enough demand for loans to use up all the increased lending capability. More supply than demand pushes borrowing costs downward, which is the point.

QE and circulating money aren't completely unrelated, but the one doesn't directly cause an increase in the other.

The thin air phraseology seems to refer to digging ore out of the ground instead. That led to very serious problems when it was the monetary system. Under US bimetalism sometimes there was inflation, but the bigger issue was the deflation caused by the Coinage Act of 1873, which put us strictly on a gold standard; and what it did to debtors, especially farmers whom, of course, we all need in order to get enough food, was terrible. International agricultural trade was much lower back then.

The Coinage Act of 1873 was known to its victims, for short, as the Crime of '73.

PJW

Topic Author
Sinsji
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Re: QE practical consequence?

Post by Sinsji » Tue Dec 03, 2019 5:30 am

Thanks for all the replies. Spend less time reading around here obviously.

Even Central Bank leaders don't agree on the correct policy...

I currently allocate most of the fixed income (20%) to a (EURO hedged) Aggregate Bond Index by iShares.
- weighted av. duration 8.77 years
- weighted av. coupon: 2.45%

Within duration: 45% <5 years, 31% 5-10 years, 11% 10-20 years and 13% > 20 years approximately.

I certainly hope I didn't put this money into the modern equivalent of war bonds

The remaining 5% into GOLD and TIPS. I don't know yet to what extend aggregate bond ETFs allocate towards TIPS.

garlandwhizzer
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Re: QE practical consequence?

Post by garlandwhizzer » Tue Dec 03, 2019 1:44 pm

In theory QE by over-stimulating the economy with ultra-low rates might produce inflation. In practice that hasn't happened. Japan 10 year bond yields have had essentially zero or negative yields for 4 years running and have been below 2% for 20 years yet their inflation rate is barely above zero now and currently declining in spite of more aggressive QE than the US did in the depths of the GR. Our FED has produced what by US standards are ultra-low rates of more than a decade and have been unable to push our inflation rate to the 2% inflation target. Europe has been stuck in slow growth, zero rate policy, and close to zero inflation for years. The dominant risk to most DMs at present appears not to be inflation but deflation/stagnant/slow growth. Ultra aggressive monetary policy has been in effect pushing on a string trying in vain to stimulate robust economic growth. Aggressive QE may have prevented another GD in 2007-9. It was IMO necessary at the time, but such desperate monetary policy had never been done before. History therefore offers no guide as to how the interplay between massive QE and the economy will ultimately unfold before it's over, if in fact it's ever over. Another reason, if you needed one, for not expecting the full robust historical rates of return going for bonds and stocks going forward. We're in a place we've never been before.

Garland Whizzer

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