Quantitative Easing Effects – The Irresistible Force Paradox by Jennifer Thomson, Gavekal Capital Blog
I enrolled in auto-tutorial physics my senior year at college. At the time, it seemed a more reasonable (read “easy”) choice, given that I didn’t remember much of the calculus I took freshman year. I quickly realized that enduring a calculus refresher might have been considerably more enjoyable than the ten units– each completed by passing a one-on-one oral exam with a professor– that were required to pass the class. On the bright side, I had a very good understanding of the material and I even remember a very little bit of it today. As a result, it is difficult to avoid thinking of what is commonly known as the ‘irresistible force paradox’ when attempting to gauge the effects of central banks’ quantitative easing (QE). Basically, this paradox asks the question: what happens when an unstoppable force meets an immovable object? Without getting into too many of the details and (even somewhat philosophical) points of contention that this query prompts, let’s simply focus on one portion of the answer– Newton’s First Law (aka the law of inertia). Most of us are familiar with the fact that “an object at rest stays at rest and an object in motion stays in motion with the same velocity and in the same direction unless acted upon by an unbalanced force”.
Thus far, the ECB has committed €60 billion per month to its QE program. As we have seen here before, that level of asset purchases (Draghi’s opening effort at creating an irresistible force) appears insufficient to effectuate the desired change in the immovable object in question.
What’s more, we have also noted (here, here, and here) that there appears to be a less desirable effect on things like stock prices– a very different relationship than what we have seen in the U.S. model. As the Fed executed its various QE programs, the S&P 500 rose fairly steadily, only beginning to slow and falter as the level of assets on the bank’s balance sheet declined. In Europe, however, stock prices have historically fallen (red line, inverted, on second chart below) as the ECB’s asset base has grown.
And so now, on the eve of the next ECB meeting, in the midst of considerable speculation about whether or not Draghi and the rest of the governing council will choose to augment the bank’s force (thereby increasing the chances that it becomes ‘irresistible’), we offer a brief review of where we stand with respect to QE’s effects so far.
Assets versus European Equity Markets (inverted)
Assets versus VDAX (the implied volatility of the Germany DAX; similar to the VIX)
Assets versus Bonds
Assets versus Commodities (note Oil is inverted)
Assets versus Currencies
Assets versus Survey Data
Assets versus Banks’ Lending
Assets versus House Prices
We can’t say whether or not an accelerated increase in the size of the ECB’s balance sheet will result in any significant change in direction or velocity for some of these ‘immovable objects’. If the current pace is maintained until the end of 2016, the level of assets will surpass the previous peak of ~€3 trillion by another €500 billion or so (red line). If, as some of the more exuberant estimates suggest, the pace of purchases increases to €100 billion per month, the ECB’s balance sheet would exceed €4 trillion by the end of next year (dark blue line).