The QE deflation puzzle: James Saft

November 5, 2013

Nov 5 (Reuters) – When it comes to creating inflation, bond
buying by central banks may actually ultimately be

Called quantitative easing, it continues to be a mainstay of
the policy reaction to the ongoing economic malaise. Yet here we
are five years later and the evidence that QE can kindle
inflation, much less revive the economy, is decidedly mixed.

In part that may be because everyone realizes that QE isn’t
forever: ultimately the bonds the bank buys will have to be
repaid. It is also true – and here we can consider the
remarkable valuations of Twitter and Pinterest – that QE causes
bad investments, which ultimately must be deflationary.

With U.S. inflation rising just 1.2 percent year on year in
September, well below the Fed’s 2.0 percent target, bond buying
by the Federal Reserve will continue – a bit like the old joke
about beatings carrying on until morale improves.

Very radical increases in bond buying in Japan under
Abenomics – more or less a pledge to buy and buy assets until
inflation reaches 2 percent – has also had only mixed success so
far, with core inflation flat in the year to September. That
this, the first time Japan core inflation hasn’t fallen outright
since the end of 2008, is seen as a victory is itself a bit of
an indictment of extraordinary monetary policy.

Dangerously falling inflation in the euro zone has prompted
calls for the ECB to join in the bond buying, despite its signal
lack of success elsewhere. The ECB is arguably already engaging
in QE as its program of providing long-term financing to banks
often leads to banks buying government bonds themselves.

So, QE everywhere, and everywhere unsatisfactory inflation
and at least the threat of falling prices. Could there be a
relationship? Part of the failure of QE may be explained by the
fact that as a percent of broader money supply the amounts
involved are small. Banks must lend and businesses invest or QE
will be swamped.

In some ways, all of the inflationary effects of QE are
short-lasting and liable to reversed. Not only is everyone
involved aware that ultimately the bonds are not being bought
and burned, but bought and held, and thus must be repaid or will
be sold by central banks.

Also, QE encourages private investors to gamble a bit,
perhaps leading to poor choices.

“Unproductive investment is by nature ultimately
deflationary,” Michaela Marcussen, global head of economics at
Societe Generale, wrote in a note to clients. “This is a point
also worth recalling when investing in paper assets fueled by QE
liquidity and not underpinned by sustainable economic growth.”


And this brings us to the quite remarkable boom in initial
public offerings, particularly in technology.

Twitter, that 160-character microblogging wonder, raised the
top end of its IPO price range by 25 percent on Monday. The
company, whose offering will price on Wednesday, may end up
being valued at almost $14 billion, or about 13 times revenue.
Not 13 times earnings, but 13 times revenue.

For comparison, Boeing, which makes airplanes rather than
selling ads against tweets, fetches a bit more than one times
sales. Microsoft goes for about 3.5 times sales.

Pinterest, an Internet service which allows users to post
pictures and other media, raised $225 million recently in a
private deal placing a $3.8 billion value on the company. That’s
$158 for each of its 24.9 million users. I can’t give you a
price-to-revenues figure because Pinterest has never reported
revenues and very well may not have any.

Now clearly Pinterest and Twitter are growth companies, and
may well amply repay their investors with future actual profit
derived from future honest-to-God revenue. But there can be no

Things feel a bit bubbly and the problem with bubbles is at
least two-fold. In a bubble, people build and invest in things
which aren’t themselves needed and ultimately don’t create
genuine revenue and growth. Think of all the rotting houses in
Florida during the crash, or the empty cities of dusty
apartments and stores in China (which themselves are arguably
the fruit of QE).

Those investments were stimulative for a while, but
ultimately highly deflationary.

In different ways, though by different paths, the same thing
may prove to be true about investments made now during the time
of QE.

All debts ultimately must be repaid, defaulted upon or
forgiven. Not much progress has been made on any of those three
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at and find more columns at

(Editing by James Dalgleish)

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