QE3 no panacea for U.S., Canada

Extrait de: QE3 no panacea for U.S., Canada, Nicolas Van Praet, financial Post, Aug 27, 2011

MONTREAL — Like junkies aching for another high, investors have been pushing for U.S. Federal Reserve Chairman Ben Bernanke to deliver a third round of quantitative easing to give them a shot in the arm and help goose the economy.

And why not? When he hinted a second round of asset purchases a year ago, it fired up an eight-month rally in the S&P 500.

In Canada, however, nobody is talking about quantitative easing — creating money by buying government securities from banks and brokerages who then lend the proceeds out to businesses and consumers. Our economic predicament is simply not despairing enough yet to reach for that monetary policy tool. And besides, as experience in the United States suggests, it may not be such an effective tool in the first place.

When the spectre of quantitative easing, or QE, comes up in the markets and among central bankers, it’s mostly because of fears of deflation. The worry is that as the economy contracts and more people find themselves out of work, they can’t afford to buy goods at even cheap prices.

The deflation ghost spooked U.S. investors last year. And the Fed recognized that. To fight it off, it started talking loudly about the possibility of a second quantitative easing program. By the time it pulled the trigger, inflation expectations had returned to about 2%. The actual buying of the bonds lifted equities and boosted overall market confidence.

But there isn’t much evidence that the program had any impact on creating jobs or generating economic activity, says Craig Alexander, chief economist At Toronto Dominion Bank. And when it ended, markets re-evaluated the economic and global risks that were present. The result? A reversal of all the equity market lift the fed’s asset purchases generated.

Quantitative easing isn’t the silver bullet people may think it is, Mr. Alexander argues. “I don’t think it solves the problems in the U.S. And I don’t believe that additional stimulus will have a really significant impact on the economy because

I think the monetary policy transmission mechanism is broken. It’s like driving your car and you have a gas tank that’s half full but your transmission is shot.
Even if you fill up the gas tank to full
your car doesn’t go any faster.”

Mr. Alexander says the United States is caught in a liquidity trap — a situation in which the traditional reaction of the economy to lower interest rates is impaired.

The predicament is a result of several things, notably the enormous foreclosure problem of the U.S. real estate market. Foreclosures are increasing the supply of properties on the market, and sapping demand by killing the confidence of prospective buyers.

Data from the National Association of Realtors shows the U.S. inventory of existing homes available for sale was 3.65 million at the end of July.

That represents 9.4 months of supply at the current sales pace, up from 9.2 months in June. The national median existing home price for all housing was $174,000 in July, down 4.4% from a year earlier. Distressed homes, including foreclosures and short sales typically sold at deep discounts, accounted for 29% of all sales at last count.

NAR chief economist Lawrence Yun said despite the most affordable conditions for buying a home in 40 years:

Buyers are being held back because banks are offering financing to only the most highly qualified borrowers and ignoring a large share of otherwise creditworthy buyers.

Weakness in the real estate market in turn is damaging the U.S. financial system. Mr. Alexander puts it this way: If you’re making loans to individuals and it’s secured by an asset and that asset is declining in value, you’re less inclined to extend the credit. So in many cases, financial institutions in the United States are still not willing to lend to people and businesses the way they would in normal conditions.

“It doesn’t matter what the interest rate is if no one’s going
to give you a loan,”

Mr. Alexander says.

“And the resolution of the foreclosure problem and the resolution of the fiscal challenges lie in the political domain. It’s outside the scope of the central bank.”

Canada doesn’t have a credit availability problem and it doesn’t have a housing market crisis. The jobs picture, while far from ideal, is still manageable with about 7.2% of adult Canadians unemployed. Gross domestic product has rebounded to pre-crisis levels.

More important for a central bank considering QE, the risk of deflation is non-existent. The country’s annual inflation rate stood at about 2.7% as of July, the 10th-consecutive month that overall inflation has been above the Bank of Canada’s 2% target.

Many of the economic risks Canadians are worried about — contributing to a 6.6% drop in the Conference Board of Canada’s consumer confidence index in August, its first substantial month-to-month decline in four months — nevertheless remain outside our borders: Europe is mired in a sovereign debt crisis that threatens to unravel its currency union; the United States is gripped by a political crisis that threatens its deficit-fighting efforts.

“There’s not much that quantitative easing in Canada could do to solve any of those problems,” says Craig Wright, chief economist at Royal Bank of Canada.

Mr. Wright views Bank of Canada governor Mark Carney’s monetary policy options to stimulate the economy as a continuum. And he says we’re not even at the start of it. The current overnight rate of 1% could be lowered to 25 basis points. The Harper government could also jump in with some fiscal stimulus, as finance minister Flaherty recently indicated he is prepared to do if necessary.

In its April 2009 monetary policy report, the central bank outlined three considerations to achieve its 2% inflation objective if rates were already as low as they could go: introducing language indicating it intends to keep rates low for a longer period than previously expected; buying private sector assets in certain credit markets that are temporarily impaired; and quantitative easing.

For Mr. Carney to even consider asset purchases, however, the economic outlook globally and domestically would have to deteriorate significantly, economists interviewed for this article said. The current major risk to Canada — that its largest trading partner, the United States, may sink into recession — is not enough.

Yes, the U.S. economy grew at a measly 1% annual rate in the second quarter, government data showed Friday. But that’s still growth, not contraction.

“We’d have to be in a very deep recession, lasting at least a year,” before we consider QE, says Avery Shenfeld, chief economist at the Canadian Imperial Bank of Commerce. “We would have to see a threat of outright deflation and we would have to have exhausted the other policy tools. It isn’t under discussion right now because we’re so far from that.”

You don’t do quantitative easing to act pre-emptively, says National Bank economist Stéfane Marion. “You do it because things are really not going well.”

There are dangers to pulling the QE trigger.

Using it in Canada in the current environment could lower interest rates further on everything from cars to houses to loans, increasing the risk of borrowers to take on debt they may not be able to manage if economic conditions change, says Sebastien Lavoie, economist at Laurentian Bank Securities.

Remarque avec un taux d’endettement de 150 à 180 %, on a déjà atteint le seuil critique, on doit remercier les gouvernements et les banques pour le crédit facile.

Worse, if it doesn’t work, deflation could lead to stagnation, says Finn Poschmann, economist at the CD Howe Institute in Toronto. “It’s only the right solution if it’s matched to the problem,” he says. “And there is no guarantee that what is driving the pathology you’re seeing is a financial monetary matter.”

Japan found that out the hard way.

When the nation’s commercial real estate market went bust in the 1990s, its central bank failed to cut interest rates quickly in response and the country plunged into recession. When it did eventually begin to cut rates in 1995, the economy failed to respond.

“It was basically a signal that there were structural problems in the economy and they needed to be dealt with,” TD’s Mr. Alexander says. “And that’s what the U.S. is trapped with today also.”

In the end, Mr. Bernanke did not give investors what they wanted Friday. He did not confirm another round of stimulus. The central bank has already bought US$2.3-trillion in bonds. Buying more wouldn’t necessarily do a whole lot to fix the economy, even if it would give the markets another temporary tonic.