I’m still shorting France, QE or no QE

Money printing changes nothing

Last week, we looked at the latest round of the QE race. Europe now looks set to take the baton in the global relay race that is money printing.

As I arrived in France this week, little did I know I’d have questions to answer on the subject. At Sunday lunch with some friends, it was put to me: “But Bengt, you’ve advised a short position on French stocks. How does this tally with the new QE [quantitative easing] initiatives that are sure to come? If the ECB [European Central Bank] starts printing, then surely France will get its fair share?!”

It’s a fair point, and a fair question. And I guess a fair answer is, well… yes, but then again no.

The QE fairytale

Let’s first remind ourselves of the thrust of QE.

The central bank invents a load of new cash out of thin air and uses it to buy bonds. Now, in the UK, the only question was which end of the yield curve to buy (the maturity of the debt)?

Other than that, the bank bought the bonds in the market. Whoever wanted to sell could do so. That included banks, hedge funds, insurance funds, pension funds… even me!

In Europe, QE will be a little more complicated, because there’s 12 different governments’ bonds to buy. Which should the ECB buy? Well, the chances are they’ll focus on the bonds of countries that are suffering most from deflation. Those are also the governments most in need of a helping hand – the so-called ‘peripheral nations’.

It’s a seemingly ‘free’ way of lowering the interest rate on the periphery debt, while at the same time, giving the former bond holders fresh cash to invest where they want. Specifically stock markets!

So far so good. And if France is indeed blessed by ECB largesse, then maybe I should fear for my short France position?

QE changes nothing

But the key things to consider are: who will be selling their bonds to the ECB? What will they do with the proceeds? And what is the ECB going to do with said bonds, once purchased?

Let’s not forget, these QE shenanigans are, at heart, aimed at saving the banks. While the bluster may be about conquering deflation, the truth is, it’s the banks that would be hit hardest by a deflationary death spiral.

It’s likely to be large international banks that trade in their peripheral bonds for newly minted cash; bonds that they had bought on the assumption that there was no risk attached. Portfolios of government debt were built during the good times, as these bankers thought they were so clever in playing the ‘bond arbitrage’ games. In the case of southern European debt, it was an arbitrage too far.

There’s no reason for local pension funds and insurance companies to cash in. After all, the rationale for holding local government bonds may still be intact.

Money will pour out of the ECB, and right back into it

Next question. What will the recipients do with the proceeds of selling said bonds? Reinvest the money locally? I highly doubt it.

We’re dealing with international banks playing global capital markets. They can reinvest wherever they like, or (as is quite likely), they can just park the cash at the ECB. The cash makes a round journey to whence it came!

And if they do decide to pick up stocks, then which ones to buy? Well, I’m just glancing over at the weekend FT. German stocks trade on a price/earnings (p/e) of 16.3 times. Oh and then there’s France – you’re going to have to pay an eye-watering 18.5 times for them. Now, why is that?

Is France any better placed than Germany right now? I’d say, definitely not. If anything, newly printed money that ends up in the pockets of international banks will flow internationally. And if the end effect is to bolster stocks, then surely the money will flow toward the best investment case… maybe even outside Europe!

Yes, there’s a lot of talk about new money making its way to emerging markets. After all, those are the markets that have been hit hardest by talk of US QE withdrawal. This could be good news for us.

QE is a poisoned chalice

But before we leave the subject, let’s just look at the last bit of the jigsaw. What will the ECB do with its new portfolio of periphery bonds? Well, just as in previous QE efforts, the central bank will do absolutely nothing. Oh, except to collect interest from the indebted periphery nations, that is!

Yes, the ECB will happily sit on Greek, Italian, Portuguese… and even French debt. But don’t for one moment think it’ll allow these nations to relent on paying the piper. In fact, it’s great business for the ECB. Create cash out of thin air, buy some bonds and collect interest on them.

Remember, despite the rhetoric, these efforts are there to help the central banks help the banks… and themselves!

The MoneyWeek team has been on QE’s case for a long time. They want to make sure you’re up to date on how central banks are manipulating the markets – and what it means for your money. So, if you’re not already a subscriber, why not try a free trial of the magazine? After all, the banks certainly aren’t going to keep you informed.

And as far as my short France bet goes, the other side of the trade was to go long German stocks. And nothing has changed as far as the rationale for this trade goes. So let’s be happy. After all I’m still on holiday. Hum along with me if you will…

Happy days are here again
The skies above are clear again
So, let’s sing a song of cheer again…

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