Federal Reserve Ends Quantitative Easing

During the 2008 financial crisis, Warren Buffet compared the US economy to a heart attack victim lying flat on the floor.

Buffet’s analogy has continued to be a useful analogy as the Federal Reserve pumped medicine into the economy in the form of buying bonds on the open market in a program known as quantitative easing, or simply QE.

That program came to an end yesterday, so you could carry the doctor/heart attack patient a little further by saying that the economy is now off of some of its medicine.

The patient, while not as weak, is not strong either and continues to get some treatments in the form of low interest rates and a large Fed balance sheet (it won’t buy new bonds, but it still holds a lot and doesn’t intend to sell anytime soon).

In my judgment, the end of QE is a relief, although it’s important to note that this is actually the end of QE3 – there were two previous rounds and the Fed felt that it needed to start up again to revive the economy. One of the not-so-funny jokes for a while was about QEI, the ‘I’ referring to infinity.

It was a controversial program when it was initiated because, in a sense, it is simply a different way to print money, which could stoke inflation and weaken the value of the dollar.

Also, the Fed represented a large artificial buyer in the market, thereby distorting normal market forces and propping up bond prices for sure, and probably stock prices as well. Some people, although I am not one of them, think that the Fed activity has created another stock market bubble (expensive, but not a bubble – there’s a difference).

Just as you can’t judge the success or failure of a President on the last day of their term, it will be some time before we can say whether QE was a success or failure.

The world didn’t end, but maybe it wouldn’t have ended anyway or would have done much better without the program. Maybe the crash would have been worse, but the recovery would have been faster. We’ll never know.

Thus far, we haven’t had any inflation to speak of (and we’re worried about deflation) and the value of the dollar is basically unchanged since the beginning of the first QE program back in late 2008.

While that’s good news, if either of those shocks hit the market tomorrow, we won’t be able to say that QE wasn’t part of the equation even though the program was technically over.

As you might expect, QE has been a fertile area of study in academia, although most of the summaries that I have read suggest that researchers think that it helped, but can’t say by how much with any precision.

Of course, it’s not over yet.  It’s conceivable, though unlikely, that we could have QE4 in the US, but more importantly, most other central bankers are still knee (or neck) deep in bond buying programs.

And, perhaps more importantly, the big experiment isn’t over yet either. The end of QE doesn’t mark the beginning of tightening monetary policy, only the end of loosening monetary policy.

Fed Fund rates are still at zero and aren’t going to change for at least six months (or so we think) and the Fed will still be reinvesting their now massive bond portfolio.

At this point, they will reinvest all of the interest payments and maturities and have no intention of shrinking their balance sheet as the bonds that they bought mature.

It’s a good day and one worth noting, but to go back to the heart attack metaphor, we’re still not in perfect health and there are plenty of risks to consider.