James Rickards is a hedge fund manager in New York City and the author of Currency Wars: The Making of the Next Global Crisis from Portfolio/Penguin. Follow him on Twitter at @JamesGRickards.
The past three weeks have been the most momentous of the year for financial markets.
On August 30, Federal Reserve Chairman Ben Bernanke offered broad hints that more money printing, so-called quantitative easing or "QE," was coming soon. The earlier quantitative easing programs known as QE1 and QE2 had come and gone. Markets were looking for a new dose of easy money. Bernanke offered a detailed case that concluded money printing was having a beneficial impact on the economy and employment and that another round would have some additional positive effects.
On September 6, the European Central Bank announced its own form of monetary ease. This program was technically different from quantitative easing. The European Central Bank would print new money to buy government bonds exactly like the Federal Reserve. However, the European Central Bank would then remove the newly printed money by offering deposits to the banks that were selling the bonds. The net effect of the purchases and the deposits would be that no new money would be created. But, the operation would put a lid on European sovereign bond interest rates and provide relief for that beleaguered sector. European stocks and bonds and the euro all rallied on the news.
September 7 saw the release of a worse-than-expected employment report in the United States. This all but guaranteed more easing by the Fed because lack of progress in the jobs market was one rationale the Fed gave for new money printing. As if on cue, the Fed announced new quantitative easing on September 13.
This new program was different from QE1 and QE2 in one important respect. The prior programs had involved purchases of specific types of securities in specific amounts to be completed in defined time periods. The new program has no limits. The Fed can buy unlimited amounts of mortgages, Treasuries or other securities for as long as they want. The idea is to keep printing money until the Fed's goals on ,employment are met. The new term of art for this unlimited money printing was "open-ended." U.S. stocks and gold rallied on the Fed's announcement.
But there was still one dog that had not yet barked. While the Fed and European Central Bank were making a splash, the third leg of the global economic stool, China, was strangely silent. In early September, there were some Chinese announcements about new infrastructure projects, but these had already been expected by the markets and had more to do with fiscal stimulus than monetary ease. The world was still waiting for a third easing announcement from the People's Bank of China following those by the European Central Bank and the Fed. China is in the midst of a once every 10 years hand-off of power from President Hu Jintao to the expected new President Xi Jinping. In such a delicate environment, the People's Bank of China might be expected to be more cautious than usual.
On Thursday, September 13, even as the Fed was making its easing announcements in Washington, People's Bank of China officials met secretly in Shanghai with members of its private advisory board to get market input regarding its policies. The advisers told the People's Bank of China that interest rate cuts were having little or no favorable impact on business conditions in China. This was because of the short maturities of the funds the People's Bank of China was making available to the commercial banks. Banks could earn 3 percentage point spreads by borrowing cheaply from People's Bank of China and lending to commercial borrowers. The problem was there was no assurance that the low funding rates would remain low over the life of the loans. The People's Bank of China had never offered the "extended period" language that the Fed had offered banks in the United States. Our banks could borrow short and lend long with confidence that short-term rates would not spike before the loans were repaid. Chinese banks had no such assurance and therefore would not make the needed loans.
The private advisers told the People's Bank of China that the best way to get commercial bank lending and money supply growing again in China was to lower bank reserve requirements and loan-to-deposit ratio requirements. Both of these moves would allow Chinese banks to make more loans using the same capital base they had already. This increased leverage would increase returns on equity for the banks and offset some of the risk of borrowing short and lending long.
It is highly likely that the People's Bank of China will follow the advice provided to them. Look for the People's Bank of China to cut either the reserve ratio or the loan-to-deposit ratio, or both, in the next 30 days. This ease, along with ramped up infrastructure spending, should give the Chinese economy the boost it needs to grow above expectations through the end of 2012 and into 2013.
With important elections looming in Germany, Italy, and the United States, and a leadership change in China, it is fortunate for the power elites in the three major currency zones that the their central banks have seen fit to provide monetary ease in a timely and seemingly coordinated way. Call it three easy pieces. Things will not be so easy for the citizens in all three areas when they suffer the inflation that will eventually follow.