Reading the wind

Former chair of the U.S. Federal Reserve Ben Bernanke gambled when he carried out the second round of quantitative easing (QE2) in November 2010 after he introduced the first batch of unconventional open-market purchasing securities from financial institutions in March 2009 to contain the financial meltdown following the bust of Lehman Brothers in late 2008.

The central bank is, as a lender, a last resort. It must provide the money to keep the liquidity flowing and the financial system running. When even the too-big-to fail fell one by one from the Wall Street-triggered perfect storm, the money stopped flowing, as nobody knew who would be next.

The unconventional QE program, otherwise known as large-scale asset purchase, came to the rescue. Traditionally, the central bank moderates the interest rate to influence short-term yields and generate changes in lending and deposit rates and longer-curve market yields to affect the broader economy.

Bernanke’s QE was designed to buy back long-term treasuries and mortgage-backed securities from the open market. It was bypassing the traditional circulation route by lowering the long-term interest rates through the direct sucking up of supplies.

Long-term treasuries and public bonds will lose appeal if they become too expensive from sharp decreases in yields. Bernanke hoped the move would shift investment to corporate bonds, which also would boost the value in shorter-term fixed debt, or lower the yields. As a result, interest rates would become lower, in the negative zone, as interest rates were already at zero, and thus inflate the liquidity and value of fixed assets.

There was a downside to capital centralization in the stock market.

The equity market could become overheated, whereas demand elsewhere stayed subdued. But Bernanke pushed ahead with QE2 in the belief that asset inflation would help to improve the overall economy. Richard Koo, a senior economist of Nomura Research Institute, likened the action to “putting the cart before the horse,” as it was forcing the economy to go the opposite of how it naturally works — improvement in the value of assets as the outcome of a better economy.

Bernanke’s adventure half succeeded, as the U.S. economy has recovered and expanded at a stable pace. But the task had been costly.
The bond purchase program expanded the Fed’s balance sheet from less than $900 billion before the crisis to about $4.5 trillion. The Fed stopped buying large quantities of assets from October 2014. Now it is ready to reduce the yawning stretch in its balance sheet. From next month, the bank will stop replacing maturing securities to incrementally shrink its bond holdings.

The matured bonds will return to the market to initiate a quantitative tightening process, or the reversal to the post-crisis massive easing.

The Fed was carrying out the liquidity sucking accompanied by normalization of interest rates upon confidence in the recovery pace in the United States and global economy and to navigate a soft landing in the bullish stock market.

The U.S. stock market is sizzling hot, awash in easy liquidity. But some of the money can return to the debt market as the tightening or increase in supplies could push up yields or make long-term bonds cheaper to buy.

Central banks around the world have been incessantly pumping out money for nearly a decade. The time has come for them to turn the spigot and reduce the flow. But since tapering off is unprecedented, they are unsure about the speed and scope of tightening.

The procedure will likely weigh on the global economy. It could stoke long-term yields and dampen the demand in durable assets like automobiles and homes. The global economy could turn lethargic again. Then the central banks would have to repeat the process of opening up and closing off the money pipelines.

They will then find themselves sinking deeper into the quantitative trap.

Much of the easy liquidity made its way into the emerging markets, where interest returns were higher and economies performed better.

The capital invested in the Korean market could pack up and return home. Currency value and equity could become battered from a “tightening tantrum.” Bank of Korea Governor Lee Ju-yeol said, “The algorithm [to aid the economy] has gotten complicated.” Monetary policy aiming for financial stability must “lean against the wind.”

The BOK must read the wind well to navigate this perilous financial climate.

JoongAng Ilbo, Sept. 25, Page 36

*The author is the business news editor of the JoongAng Ilbo.

Kim Jong-yoon