QE3 is a whole new beast

America's first two rounds of money printing were all about fixing the broken financial system. But this time it's different, says Merryn Somerset Webb.

Years ago, back when all this first started, Bill Bonner and I talked about how it would play out. He said central banks would print money. Then they'd print more money. Then they'd get addicted to printing money. And then there would be inflation. You can make the crisis and its ongoing semi-resolution sound a whole lot more complicated than that if you like, but in the end that's more or less what is happening.

America, as ever, is rather ahead of the rest of us. Its first two rounds of QE made some sense. The money supply was on the verge of serious contraction as the banks pulled back from lending. So to prevent deflation and depression the Federal Reserve stepped into the breach and printed just enough money to stop the overall supply of money falling. QE1 and QE2 were all about trying to mend the broken financial system.

But the US financial system is now more or less fixed with the supplies of credit and money growing. That makes QE3 something different altogether. It marks the beginning of the addiction phase and the targeting of a variable (employment) for which no clear transmission mechanism really exists.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

The newly created money is destined for the hands of financial institutions holding mortgage backed securities (MBS) but, as CLSA's Russell Napier points out, they won't use it to create jobs. They'll use it to buy other financial assets shares, bonds and the like.

It might end up creating employment somehow, sometime. But before it does it has to "cascade" through a lot of financial assets. And if those into whose hands it cascades decide to leverage up a little along the way we can expect the cascade to turn into a deluge.

This might not be good news for ordinary Americans after all, as Bill points out, they don't own many of the assets in question. "At best they own houses, which have gone down. At worst they own nothing but their time, which has also gone down" as real wages have collapsed.

But it's great for speculators, for those who own stocks (think of what's about to happen as a kind of predictabubble) and those who've been waiting for the currency war to kick off in earnest note that Japan has now been pushed into chucking new money into the mix too.

So what do you do? You hang on to your gold (tightly) and read John's cover story where we run through all the major asset classes and tell you just where we stand on them (an exercise we plan to repeat regularly from now on): Going cheap - bargain assets to put into your portfolio now.

Then you look at my interview with Edinburgh Partners' Sandy Nairn. The stand out point for me from our talk comes from Sandy's work on valuations and inflation. Buy something expensive now and history shows that when inflation hits 4% you'll lose money, probably a lot of it. Buy something cheap and you won't. What's cheap? The good news is that it is two things regular readers are probably already holding: European equities and Japanese equities.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.