With every passing day the Fed, which recently revealed that among its mandates are China, the VIX, the Dow Jones, and who knows what other market-driven indicator (a market which is also influenced by the Fed, leading to the mother of all reflexivity nightmares), is realizing the trap it has set for itself with 7 year of ZIRP and QE, two policies which on their own would have boosted much needed inflation (because a world drowning in $200 trillion in debt can only survive if the debt is inflated away, otherwise mass defaults are imminent), and yet has seen inflation expectations recently tumble to lows not seen since the financial crisis.
The reason for this pervasive global deflationary tide was explained by Bank of America in very simple terms, or rather letters, as follows: Deflation = Debt plus Disruption plus Demographics.
To wit: The cyclical fallout from the Great Financial Crisis and the secular deflationary “D’s” of excess Debt, tech Disruption, aging Demographics have been the major catalysts for deflation.
- Disruption: Technological innovation and disruption are driving many goods & service sector prices lower (rent & health care are two important exceptions); extending human life and the propensity to save; fostering wage and job insecurity.
- Demographics: The size of the working population of the developed world peaked in 2011 and will fall from 833 million to 799 million by 2025, putting downward pressure on potential growth and inflation (Chart 3). And by 2050, the world’s “Silver Generation” will increase by 885 million people, many of whom will save more in anticipation of old age.
- And of course record Debt: "Minimal deleveraging since the GFC and a large debt overhang remain impediments to nominal growth; global debt as a % of GDP actually rose from 162% in 2001 to 211% in 2013, an all-time high."
Incidentally, it is the last bullet, runaway debt, which has been the most insidious outcome of global "all out" QE. Over the weekend Macquarie explained the implications of this vicious loop very simply:
... the challenge is that ongoing flow of QEs prevents rationalization of excess capacity (in turn created through the process of preceding three decades of leveraging) whilst also precluding acceleration of demand (both household and corporate), as private sector visibility declines. Hence declining velocity of money requires an ever rising level of monetary stimulus, which further depresses velocity of money, and requiring even further QEs. Also as countries compete in a diminishing pool by discounting currencies, global demand compresses, as current account surpluses in these countries rise not because of exports growing faster than imports but because imports decline faster than exports. This implies less demand for the global economy.
Putting all this together with the failure of central banks to generate stable and benign inflation using existing "unconventional" means, is precisely why over the weekend BofA also made a call for a "massive policy shift in 2016", which in not so many words, was just the latest call for helicopter money, joining other banks such as Citigroup and Deutsche Bank asking for the same.
Finally, what does the end of QE and the start of something "bigger" mean? We explained that too over the weekend when we excerpted from the full Macquarie note which summarized what is coming as follows:
We believe that the path of least resistance would be to effectively ban capitalism and by-pass banking and capital markets altogether. We gave this policy change several names (such as “Cuba alternative”, “British Leyland”) but the essence of the new form of QE would be using central banks and public instrumentalities to directly inject “heroin into blood stream” rather than relying on system of incentives to drive investor behaviour.
And with that, the methadone clinic has officially given up, and is about to tell the long-suffering drug-addict that time to mainline "monetary and fiscal heroin"has come. We expect the mainstream media narrative to shortly shift to one of managing terminal expectations.
