Quantitative easing - what it is, why it's important

PUBLISHED : Monday, 08 October, 2012, 12:00am
UPDATED : Monday, 08 October, 2012, 3:14am

Central bankers do not attract much notice if economies are running smoothly. They usually come across as calm, politically neutral and academic. With a steady hand on the levers of monetary policy, they make small adjustments to keep inflation in check and economic growth at a sustainable level.

The global financial crisis shattered this image. It forced central banks into the middle of policy discussion about key issues like growth and employment. It also gave rise to a new phrase describing what central bankers are now all about: quantitative easing (QE).

QE has been used in large, mature economies to fight anaemic growth and high unemployment. The policy has legions of admirers, and equally vocal detractors who allege it is "currency debasement" that leads to hyperinflation and ruin.

With the US Federal Reserve, European Central Bank, Bank of England and Bank of Japan all employing QE in some form, what does this mean for Asian asset prices over the coming months?

First off, central banks use QE when their conventional tools (mainly, interest rate changes) no longer have much effect. In the US, benchmark interest rates have essentially been at zero since late 2008. Yet US unemployment is at an alarming 8 per cent with 12.5 million people out of work.

US Fed chairman Ben Bernanke referred in his recent Jackson Hole speech to the "enormous suffering and waste of talent" that the labour market malaise was causing. The situation in Europe is worse. Spain and Greece's official unemployment rates run at 25 per cent.

When normal policy fails, central banks engage in QE, the buying of government or other securities, to lower the cost of borrowing. For example, the latest instalment of the US Fed's QE programme targets mortgage-backed securities.

When a bank lends money to a family for a mortgage, it will package that mortgage into a type of bond that it offers to professional investors (including, now, the Fed). Once it has "sold" the mortgage, it has fresh capital to lend. So it can offer new mortgages, which explains the recent uptick in the US housing market.

Meanwhile, as the Fed pumps cash into mortgage securities - at a rate of US$40 billion a month - banks, insurance firms and funds find themselves with a lot of new money on their hands. This seeps into other markets, including Hong Kong equities. Hence the recent uptick in the Hang Seng Index.

So why is QE controversial? In a word, inflation. The unprecedented scope and scale of the latest QE means inflation concerns are legitimate. Bernanke believes the risks outweigh the benefits.

The Fed also risks stoking an asset bubble. With all the loose cash floating around out there, investors might get excited about a particular asset, creating price rises, potentially a mania and then a market crash.

For Asia, in the shorter term the economic impacts of QE are likely to be minimal. Central banks in Asia can still use conventional steps to smooth out economic wrinkles.

Asset prices are another matter, and the current QE cycle is likely to be either neutral or slightly positive as investors seek out higher yielding assets. But Asian markets don't need the help of printed money. They already have growth and best of all, boring central bankers.

Stefan Hofer is the emerging market strategist for Julius Baer