Ken Fisher: I can’t wait for monetary stimulus to end

November 29, 2013 6:44 pm

I can’t wait for monetary stimulus to end

By Ken Fisher

QE has been a massive drain on the economy

Every time the stock market falls, I read that it’s because investors fear higher interest rates. This is just such rot. Why would they fear rising long-term rates? Higher rates are supply-side monetary stimulus – which is just what the world needs now, after five years of the evil twin, demand-side monetary stimulus.So what’s the difference and why does it matter?

It’s all about how central banks manipulate money supply – the fuel for economic growth. Central banks create the monetary base – notes, coins and reserves. But banks create the bulk of M4 money supply. Through the fractional reserve banking model, they lend their reserves many times over, and this loan growth is what drives broad money growth.

So if you want more lending, you either you make banks more eager to lend – boost supply – or you make borrowers more eager to borrow – boost demand.

Throughout modern history, central banks have used supply-side policy. They’ve adjusted reserve requirements and nudged overnight lending rates to make banks more or less eager to lend as need be. Since 2008, they’ve used demand-side policy. They’ve bought huge amounts of long-term gilts and US treasuries to push down long-term rates and make folks more eager to borrow. The infamous quantitative easing.

The problem is that supply-side factors matter more than demand-side. Don’t believe it? Imagine long rates were zero. Everyone in the world would want to borrow. But banks wouldn’t lend a penny, ever. Low long-term rates might make borrowers more eager but make banks less so.

Banks’ core business is borrowing from depositors at short-term (lower) rates and lending at long-term (higher) rates. The spread is their profit. When short rates are fixed near zero and long rates are held down, profits shrink and banks don’t lend. They’re not charities.

This is why QE fails. Banks won’t take risk for no reward. When yield spreads are as small as they have been, banks lend only to the most solvent borrowers. Hence why small business lending spent the whole of British QE in free fall and M4 fell two straight years. When yield spreads widen, the risk/reward trade-off improves, and banks are keener to lend to iffier prospects.

Borrowers are still keen, too. Pretend you want a home and have good credit, so you can get a 10-year fixed-rate mortgage for 4.5 per cent. That home is £240,000 – your monthly principal and interest payment is £2,487. If rates rise half a point, your monthly payment rises by £58. Do you back off? No! You love that house! Besides, cost is just one variable. Is your income good? Your job? Do you expect your life to improve or worsen?

Once QE stops, the party will really start. Wider spreads will make banks more eager. Long shutout business owners will finally get what they need – money to invest in new technology, equipment, R&D, facilities, inventory and employees

– Ken Fisher

Or pretend you run a high street shop. You need a loan for a long-term project. Your return on investment is 7 per cent, and you have good credit, so you can borrow at 5 per cent, or 3 per cent post-tax.

If rates rise to 3.5 per cent, your profit is still 50 per cent (3.5 divided by 7) if revenues continue. So you look forward. Do you have confidence in the economy? Expect strong demand? Are your order books already bursting? If so, you’ll still take the loan. If not, you won’t and probably wouldn’t have done so at lower rates either.

Borrowers like low rates, but most don’t actually need them. You know this – UK borrowing costs have risen all year, but so has loan demand, according to the Bank of England’s credit conditions survey. Demand now is stronger than during the UK’s QE nightmare! Growth is speeding on all fronts, so businesses and homebuyers are more confident, more eager to borrow. With profits up, banks are more eager to lend. M4 is finally growing apace.

Expect the same in the US when their idiotic QE ends. QE hurt the US, just like it did Britain. Loan growth slowed and M4 is up only 2.8 per cent since QE began – and it fell for a year and a half along the way. Banks lent less, created less money. The economy had less fuel. That it grew anyway is a marvel.

The fog is already clearing. Markets are discounting QE’s end. At the end of May, the yield on 10-year Treasuries was 1.68 per cent. By the end of September, that had risen to 2.54 per cent. Bank lending rates rose too. Yet household borrowing rose 1.1 per cent during the third quarter – the first rise this year. Consumers knew it was OK to borrow even as rates rose. Businesses did too – business lending grew 1.2 per cent. M4 is growing faster.

Once QE stops, the party will really start. Wider spreads will make banks more eager. Long shutout business owners will finally get what they need – money to invest in new technology, equipment, R&D, facilities, inventory and employees. Five years of pent-up demand will be unleashed to work its magic throughout the world’s biggest economy.

And the best part? No one is expecting it! Everyone thinks higher rates will cause lending to crumble and GDP to go into free fall. They’re in for a colossal shock – just what stocks love.

Ken Fisher is the founder and chief executive of Fisher Investments