On a Tale of Two Central Banks; QE and Market Volatility; Is a Low-Carb Diet Good for You!

From: aditya rana
Date: Mon, Nov 10, 2014 at 8:23 AM
Subject: On a Tale of Two Central Banks; QE and Market Volatility; Is a Low-Carb Diet Good for You!


Central bank policies to inflate asset prices have been the key driver of asset returns over the last six years, and it is therefore important to analyse what the next phase is likely to be with the Fed exiting their QE program. With this aim in mind, I summarise below a recent article by one of the more astute observers of the European economic and monetary situation – Paul De Grauwe from the London School of Economics, who argues that the ECB has no option but to launch a full-fledged QE program over the coming months:

-There has been a stark contrast between the policies of the Fed and the ECB since 2012 – with the Fed adding $1 trillion (an increase of 25%) to their balance sheet (and thereby increasing base money-or liquidity – by a similar amount).

-However, the ECB did the exact opposite by reducing its balance (and therefore the money base) by Euro 1 trillion (a decrease of 30%) over the same period, after having increased it similarly to the Fed during the 2008-2011 period. This has occurred despite Europe not having recovered sufficiently from the sovereign debt crisis, thereby pushing its economy back to the brink of deflation.

-Why has this policy divergence taken place? It boils down to the two economies having a widely different approach to diagnosing the cause of the crisis and the role of a central bank in dealing with the crisis.

-The Fed, correctly, diagnosed that the crisis led to a balance-sheet recession with the private sector deleveraging by cutting down spending. Therefore, the Fed had to offset this shortfall in demand by aggressive monetary expansion.

-The ECB, by contrast, viewed the problem as too many rigidities on the supply side, arguing that structural reforms would increase supply which would then create its own demand. Governments were forced to implement some of these structural reforms and monetary policy was largely ignored.

-It was only in early 2014 that the ECB began to realise that its narrative did not fit the unfolding facts , as deflationary forces took hold in the economy despite structural reforms implemented by many governments. The ECB subsequently reversed its approach by announcing its desire to do some quantitative easing and increase its balance sheet.

-However, in the face of fierce German opposition the ECB was unable to utilise the easiest method of quantitative easing – i.e. the purchase of government bonds which are standard practice in other parts of the world. Instead, the ECB was forced to resort to schemes like buying repacked loans made to small-and-medium sized companies.

-So the ECB now finds itself in a bind, unable to pursue the most effective form of QE (which is buying government bonds) in the face of semi-religious opposition from Germany, instead relying on alternatives which are unlikely to increase the monetary base significantly.

-At the minimum, the ECB should take its responsibility to keep inflation at 2% seriously, which it as failed to do over the last two years. The only way to achieve this is through a significant increase in the monetary base, and the only practical method to do so is the purchase of government bonds.

-The costs of the failure to do so are high – turning away millions from the union which brings untold economic misery rather than economic welfare. The ECB needs to stop fearing the Germans.

A succinct and to the point analysis of the key issue which the world economy faces today – how to bring back Europe from the brink of deflation? The costs of German intransigence have now reached a critical point – but as they have done repeatedly over the course of the crisis – they will eventually be forced to back down. After the dramatic move by the BOJ recently, the question of when the ECB resorts to the purchase of government bonds will be the key event to monitor over the coming months.

Came across an interesting chart from Soc Gen (via Cullen Roche of Pragmatic Capitalist) which shows the Volatility Index during the various iterations of QE. It is quite clear that QE smoothed the stock market’s gyrations significantly – the S&P 500 was less volatile when QE was in place.

-“Stock markets play a huge role in people’s balance sheets as a key component of saving. And since spending is a function of income relative to desired saving then stabilizing that saving variable could go a long way towards smoothing the business cycle. And if QE contributes to smoothing some component of this whole equation then that would be an obvious positive.”

-“Historically, the stock market is actually very boring on any day-to-day basis. It averages just a 0.03% move on a daily basis going back to 1950 with a standard deviation of 1% on a day-to-day basis. So it’s positive, but just marginally.”

-“But when we look at the various iterations of QE we see a shift. The volatility increases marginally with QE1 (mainly because the Fed’s balance sheet started to increase before the crash), but the average daily return of the S&P 500 jumps to 0.12%. When QE2 is initiated the volatility drops with the standard deviation of the daily returns falling to 0.79% and the average daily return falling to 0.04%. And with QE3 the standard deviation of the daily moves remains well below the historical average at 0.88% with an average upside change of 0.07%.”

-“Interestingly, in the periods (during the last 6 years) when there was no QE the average daily return drops to 0.02% with a standard deviation of 1.3%. So the market became more volatile with a lower average return. That would imply that the market’s were much less stable without QE. Now, none of this is really that shocking to anyone who’s been paying attention to the markets over the last 5 years. There has been a “relentless bid” under the market that has been attributed to QE at least to some degree.

-“However, as Hyman Minsky once noted, stability creates instability. And so a Central Bank that is potentially putting a floor under asset prices has to be aware of the potential that irrational market participants could bid up assets higher than they can be sustained. It will be interesting to see, however, if volatility in asset prices increases now that the Fed’s implicit support is gone and whether that prompts actions to initiate a new round of balance sheet expansion. And more importantly, will we eventually find out that all of this “stability” actually creates instability? I guess we won’t know until after the fact, but for now it looks like the Fed has not increased financial instability.”

Low-Carb Diets Increase Risk of Death for Heart Patients:

Low-carb diets have become popular as a weight reduction technique (typically replacing the carbs with animal protein). While they might provide that initial benefit, are they really good for you over the long term? Apparently not, as per a recent study publish by the American Heart Association!

PRCM, November 5, 2014:


-A low-carbohydrate diet high in animal products is associated with an increased risk for dying, according to a new study published by the American Heart Association. Researchers analyzed the diets of 4,098 women and men who had previously had heart attacks and found they were 33 percent more likely to die from any cause and 51 percent more likely to die from heart disease if following a low-carbohydrate diet high in animal sources of protein and fat, compared with those whose dietary patterns consisted of fewer low-carb, animal-based products.

-A previous publication following this same population showed that a diet lowest in red and processed meat products and sugar and highest in whole grains, fruits, and vegetables lowered the risk of death from heart disease by 40 percent, compared with no dietary changes.

Here’s to maintaining a simple and balanced diet consisting mainly of whole grains, vegetables, legumes, nuts and fruits – with some lean meat added as a side-dish if you so wish!

Apologies for the late delivery of the newsletter this week – some personal matters intervened!




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