I wrote this piece on European’s Quantative Easing Programme for the Irish Times Business Section on 9th February last.
What happens to the tech sector when central banks print vast sums of money ?
Every month from November 2008 until this month, the US Federal Reserve has been generating substantial sums of electronic cash during its various “Quantative Easing” programmes. The central bank’s hoard of assets rose from a base of about US$750 billion, to about $4,500 billion today. Janet Yellen, the head of the Reserve, confirmed last October that the central bank would conclude the current purchase programme this month.
Where did these enormous sums of money end up ? The Federal Reserve purchased assets – bonds and mortgage backed securities – from the main US trading banks, in turn swelling their internal resources in a struggling economy. In theory the banks would then invest in new assets to replace those they had sold to the Reserve, make new loans, and thus pump new money into commercial ventures.
When a central bank buys up bonds and debt from the banks in this way, interest rates stay low. Thus to make money, banks seek riskier investments with higher returns. One consequence is that stocks and shares become attractive. And thus unsurprisingly, major stock indices such as the Dow Jones and S&P have now gained between 150 per cent and 200 per cent since their market bottoms of March 2009.
Venture capital funds have benefitted too, although perhaps not as much as during the dotcom boom. In 2013, some $29.5 billion was invested in just over 4,000 deals across the US. By contrast, in 2000, just before the dotcom crash, about $105 billion was invested in over 8,000 deals. Furthermore, the number of new companies coming to the stock markets (IPOs) has been relatively modest as compared to the dotcom era. Instead, the tech sector has experienced a consolidation of investments, with a relatively small number of privately held companies achieving extraordinary valuations (for example Uber at $41 billion; and each of AirBnB, Dropbox and SnapChat at $10 billion).
Since the Federal Reserve has now throttled back its activity, there is some nervousness that US interest rates may start to rise again. If they do so, there is likely to be a correction to the stock markets as investors move away from the markets and back into lower risk bonds having reasonable returns. Nevertheless, the USA now has a national debt of over $18,000 billion and if US interest rates were to rise signficantly without a proportional growth in economic activity, then the cost of servicing that debt might become a major burden on the economy. Thus, the Federal Reserve will continue to watch interest rates with concern.
Just as the Federal Reserve has turned off the tap, the European Central Bank has decided to turn it on. On January 22nd, ECB President Mario Draghi announced a programme to purchase €1,100 billion ($1,300 billion) of European government bonds, to try and stimuate the continent’s economies. One immediate impact was to place further downward pressure on the euro exchange rate, since significantly more euro will go into circulation. The subsequent election of the Syriza party in Greece just three days later has distracted many commentators (not least here in Ireland) from the ECB’s announcement, even though the ECB’s move is likely to be considerably more impactful.
What consequences might the ECB move have on the Irish tech sector? The US multinationals here should benefit from the falling euro and hence lower costs (in US dollar terms) from their Irish operations. This in turn will likely further stimulate the tech sector labour market in Ireland, as non-euro zone firms seek to place more of their activities here. If so, indigenous firms will find it even harder to find and retain staff. Pay rates will probably rise as the labour pool tightens further, putting further pressure on weakly capitalised firms. Exports to outside of the euro zone (and to the US and UK in particular) should rise as euro-priced products and services become cheaper in US dollar and sterling terms. On the flip side, indigenous firms wishing to establish and run subsidaries in the US and UK to service their customers there will find their costs of doing so rising significantly in euro terms.
How about the availability of risk capital? In principle, venture capital firms operating in Europe should find raising new funds easier, particularly if there is a reasonable track record of successful investment. More capital will be in circulation, euro zone interest rates are likely to stay low, and investors will seek higher returns than the paltry rates available for bonds and debt. Larger European firms may also find it easier to raise capital, both on European stock markets and the debt markets. In turn this may accelerate mergers and acquisitions activity, leading to more numerous exits of smaller firms and start-ups.
The ECB decision is itself high risk, not least because of the consequences of a lower euro exchange rate on non-euro economies. If a weak euro and stronger dollar were to put US multinationals under pressure in a still struggling US economy, would the Federal Reserve reconsider quantative easing ? Might we even be heading for a macabre race to the bottom of major global currencies ?