US Fed’s doubling of QE3 fails to impress markets

Central bank $tns.pngOver the past 4 years, 18 men (no women are involved) have run the global response to the financial crisis, as politicians refused to take a lead.

Instead, the world’s leading central bankers felt forced to establish their own Economic Consultative Committee (ECC). They represent countries comprising 75% of the global economy ($51tn). They now talk on a daily basis, and meet every 2 months on a Sunday night for dinner in Basle, Switzerland.

The story of the global economy over these past 4 years has thus been very simple:

• Weak consumer demand in the West weakens manufacturing in Asia, which weakens natural resource producers such as Brazil and Australia
• Central bankers step in to increase liquidity in financial markets, thinking this will support Western consumer demand and global growth
• Pension funds and others fear the arrival of inflation and a weaker US$, so boost the ‘correlation trade’ in supposed ‘stores of value’ such as oil
• Higher oil and commodity markets destroy consumer demand, leading the central bankers to increase their liquidity injections

So far, as the Wall Street Journal chart shows, they have flooded markets with $11tn of liquidity (16% of global GDP) since 2007. Unsurprisingly, given that they are operating a closed loop, nothing has changed in terms of economic growth. Instead, global debt has ballooned, leading to tax rises and cuts in government spending. These, of course, further weaken consumers.

Last week, there were new signs that the impact of this liquidity is itself now weakening. The US Federal Reserve announced a doubling of its QE3 programme to $85bn/month, This will take its debt from $2.86tn today to $4tn by December 2013. But markets failed to respond.

We could therefore be now about to see the beginning of the end for the correlation trade. In turn, markets may start to be driven once again by the fundamentals of supply and demand, rather than by central bank liquidity, and so may well head sharply lower.

Sadly, of course, the ECC – though well-intentioned – has been fighting the wrong battle. They refuse to accept that demographics drive demand, and that an ageing Western society means growth rates must slow. Instead, they believe we risk a 1930s-style Depression.

We are all paying the price for their mistaken diagnosis. And in the end, they may well end up causing the very Depression they are trying to avoid.

Benchmark price movements since the IeC Downturn Monitor’s 29 April 2011 launch, with latest ICIS pricing comments below:
HDPE USA export, down 24%. “Some producers may be selling directly overseas, particularly in Europe, and avoiding the trading houses”
PTA China, down 14%. “Chinese polyester makers may not able to pass on cost hikes given such poor polyester sales”
Naphtha Europe, down 16%. ” Demand is subdued, both from the gasoline sector and the petrochemical industry”
Brent crude oil, down 14%
S&P 500 stock market index, up 4%
Benzene NWE, up 15%. “Majority of players were now focused on January restocking, which helped support some higher prices for the forward month”

About Paul Hodges

Paul Hodges is Chairman of International eChem, trusted commercial advisers to the global chemical industry. The aim of this blog is to share ideas about the influences that may shape the chemical industry over the next 12 – 18 months. It will try to look behind today’s headlines, to understand what may happen next in important issues such oil prices, economic growth and the environment. We may also have some fun, investigating a few of the more offbeat events that take place from time to time. Please do join me and share your thoughts. Between us, we will hopefully develop useful insights into the key factors that will drive the industry's future performance.

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