The day that the world's investors have been dreading has arrived: The U.S. Federal Open Market Committee on Oct. 29 announced the end of its latest quantitative easing program, commonly known as QE3. Quantitative easing entails a central bank expanding the monetary supply through a bond-buying program. The end of quantitative easing in the United States — which is what the Federal Reserve intends for the current economic cycle — is a seismic event, signifying the breakpoint between six years of exceedingly loose monetary policy and the relatively unknown future of the global economy.
The ubiquity of quantitative easing during the financial crisis should not blur the fact that not only is it unconventional; it is unprecedented (except for Japan, where the policy was developed). For example, the global financial system usually is able to turn to the Bank of England's 300 years of monetary policy history for a precedent. However, before 2008 the British interest rate had never been below 2 percent, let alone a point where a 0 percent interest rate was considered insufficiently low to change behavior, necessitating the creation of a program like quantitative easing.
An Expected End
Of course, the news has not come as a surprise for the markets. With a slowdown of purchases — called tapering — first announced in May 2013, the quantity of monthly bond purchases has gradually dwindled all year, from a peak of $85 billion down to this month's final purchase of $15 billion. There have been signs that the markets are well aware that the end of quantitative easing is nigh. Previously sedate and sluggish prices have become erratic, and the market has seen steep and irrational jumps the likes of which were last seen in the depths of the global financial crisis. This increased volatility is a direct result of less money entering the system, with lower relative volumes allowing for less shock-absorption when news moves the markets. Add to this a large dollop of unease among investors who are trying to adjust to a new monetary environment for the first time in six years, and the volatility is quite understandable.
The U.S. economy's return to health seems set to leave the global economy suffering from withdrawal symptoms as the Federal Reserve removes its medicine.
Whether the end of QE3 is a good or bad thing largely depends on your perspective. From an American point of view, it is a sign that the U.S. economy is finally coming out of intensive care, with talk of a rate increase in 2015 that would take it a major step toward normalization; the Federal Reserve will be glad to have its traditional interest rate levers back in service. As seen in the "taper tantrum" that followed the 2013 tapering announcement, the countries with the most to lose from this development are the ones that rely heavily on international money to finance their economies. In the taper tantrum, five countries with high current account deficits — evidence that they rely on foreign capital to function — suffered a stampede out of their currencies. These countries — Turkey, Brazil, India, South Africa and Indonesia — became known as the "Fragile Five" and will be watching global markets with trepidation.
Finding a Replacement
The markets, meanwhile, will be hoping that another major central bank will be induced to undertake quantitative easing in order to fill the void left by the United States. The Bank of England, like the Federal Reserve, is currently considering whether or not to raise interest rates in 2015, so more quantitative easing is unlikely. The European Central Bank, long seen by the markets as a likely candidate, suffered a leak this week in which two of its governing council members revealed that the bank would not consider quantitative easing at least until 2015, and even then a sizable minority of council members would need to be convinced.
This leaves one major central bank: the Bank of Japan. Finance Minister Haruhiko Kuroda's grand plan, so-called "Abenomics," has had a rough 2014, with a consumption tax hike having worse-than-expected consequences and exports stubbornly refusing to pick up, despite the weak yen. It is now likely that the Bank of Japan will return to the printing press in order to sustain its inflation levels. This will provide some stimulus, but not enough to fill the hole in the global markets left by the end of QE3 in the United States. The U.S. economy's return to health seems set to leave the global economy suffering from withdrawal symptoms as the Federal Reserve removes its medicine.