Floating all boats

Everything is going up. Gold, oil, commodities, stocks, bonds, everything. All at once.

And I suppose it’s no wonder. Central banks are pumping money like there is no tomorrow. Here is how Gavyn Davies framed current central bank intervention yesterday:

The graph uses the size of the central bank balance sheet as a metric to measure the extent of the monetary injection which is occurring now that short term interest rates are at the lower bound. This metric is far from perfect, since different types of QE will certainly have very different impacts on the economy. And some actions by the central banks, such as the Fed’s Operation Twist, have the same effect as QE without changing the size of the balance sheet.

In calculating the figures shown in the graph, I have made a notional upward adjustment of $600m to the size of the Fed’s balance sheet, to represent the impact of Operation Twist and recent changes to communications policy. I have also assumed that QE3 will be launched in April at a size of $100m per month, though the probability that this will occur may be declining. For other central banks, I have assumed that announced policy measures will be followed, and have assumed a size of E400bn for the ECB’s forthcoming LTRO.

Whichever way the numbers are calculated, the overall message is clear. The central banks are engaged in a second burst of QE which will take effect more slowly than the initial round in 2008/09, but which will eventually prove somewhat larger in size. A rough order of magnitude is that QE1 increased balance sheet size by about 5 per cent of GDP, while QE2, spread over a period which will be twice as long, will be around 9 per cent of GDP. This is almost twice as large as QE1, and is far more co-ordinated across the developed world.

Yet, just about everywhere, the mechanisms of transmission to the real economy of all this free dough remain broken. In the US, households either don’t want to borrow or their balance sheets remain under water and can’t. It is striking that the savings rate there continues well above the levels of recent decades despite the appalling returns from bank accounts. The same slack credit demand afflicts Europe, either in the periphery where austerity and falling asset prices has households aiming to rebuild balance sheets, or in the core where nobody ever borrowed much anyway. Then there are the European banks which don’t want to lend when they can make much less risky profits with simple carry trades between their sugar daddies at the ECB and national government bonds. In China we can expect similar dynamics to take a hold of real estate- exposed sectors, irrespective of stimulus, which will be targeted around said market.

But, as we learned through successive episodes of quantitative easing in the US, when the mechanisms of transmission of free dough to the real economy are broken, money seeks out assets. This time the pecuniary gush is coming from all directions, so rather seeing dollar or undollar assets rise or fall, it’s pretty much anything you can lay your hands on anywhere.

Will this restart global growth? Given the broken credit mechanism, the only possible effect of this combined stimulus on growth is the temporary floating of private balance sheets via asset inflation. So yes, it may have some temporary effect on boosting demand.

Will it create a lasting recovery? Sadly no. Asset inflation is already threatening demand in the US with oil at $105 per barrel. A new pulse of production inflation will also arrive as it goes higher.

So, where are we? Somewhere on the way up in another ephemeral round of central bank inspired asset price mayhem with risks of Europe and China temporarily forgotten. China especially remains an unknown.

Keep your finger on the trigger.