After a decade of extraordinary monetary policies, central banks had started a long, slow march back to normality. They hadn’t got very far before turning back again.
Central banks around the world are back in easing mode. The Federal Reserve delivered a quarter-point interest-rate cut last week despite data suggesting the US economy remains robust. The European Central Bank (ECB) has also taken an increasingly dovish line and is widely expected to cut rates this September – the main deposit rate is already -0.4% – and to resume bond purchases later this year. Some want even more radical measures. Last month Larry Fink, CEO of asset manager BlackRock, called on the bank to use quantitative easing (QE) to buy up European stocks. For such a prominent capitalist to advocate what amounts to the partial nationalisation of the stockmarket is a sign of the extraordinary times we live in.
How easy has money become?
The era of loose monetary policy arguably dates back as far as 1995, when US Fed chairman Alan Greenspan delivered an “insurance cut” in the midst of an expansion. Average rates continued to fall in the aftermath of the dotcom slump, but it was the 2007-2008 financial crisis that delivered the largest and most enduring cuts. In 2007 the Bank of England (BoE) base rate was 5.5%. Prompted by the crisis, rates fell to 0.5% a decade ago, then the lowest level in its 325-year history. What was supposed to be an emergency measure has turned into the new normal. Today, UK interest rates are still just 0.75%. With the cost of borrowing near zero, central banks turned to a more unorthodox policy tool.
What is quantitative easing?
A central bank electronically creates new money and spends it in the financial system, usually by buying up government bonds. By bidding up bond prices, the returns available to investors from bonds fall. That is supposed to prompt savers and institutional investors to direct cash towards slightly riskier investments, such as corporate debt and equities. The theory goes that this makes it easier for businesses in the real economy to borrow, stimulating investment and boosting flagging demand. At their height, central-bank QE policies dumped as much as $14trn into the global economy. The BoE and the Fed purchased assets amounting to a quarter of the GDP of their respective economies. The ECB’s programme equalled 40% of the eurozone’s economy; at almost 100% of GDP, the Bank of Japan’s (BoJ) balance sheet is the world champion.
Did it work?
With the collapse of Lehman Brothers unleashing financial contagion, the display of central-bank firepower helped to ensure that the financial crisis and resulting recession were not even more severe. Their performance compares favourably with the destruction wreaked by hawkish central bankers during the Great Depression. Yet, as Doug Noland of the Credit Bubble Bulletin argues, the cure has now become worse than the disease. Like “steady doses of antibiotics”, the overuse of these policy tools has rendered them ineffective. Low interest rates have turned into a “narcotic” for sustaining unsound booms. As the 2013 “taper tantrum” revealed, markets wilt whenever bankers try to wean them off their addiction to cheap money.
What are the problems?
QE has been too successful at easing credit conditions. Capitalism depends on the “creative destruction” of badly run or outdated businesses. Yet a recent analysis by KPMG suggested that as many as one in seven UK firms might have collapsed without the help of easy money. Such “zombies” may be playing a role in Britain’s productivity problem. It also speaks to a broader issue: loose money has created a financial wonderland of distorted price signals and asset values detached from their fundamentals.
So it blows up bubbles?
Yes. The values of stocks and bonds usually move inversely: the latter are a safe haven to which investors turn in a storm, the former a riskier option for when times are sunnier. Yet the wall of money unleashed by central banks has seen the two rally together this year. Interest rates on about $13trn of debt worldwide have now turned negative, particularly in Europe. Even sovereigns as risky as Italy are able to borrow for a decade at rates well below 2%. This looks dangerously like a bubble, says Noland. The “bond vigilantes” who used to keep profligate governments in line are “extinct”.
Are we in for a nasty reckoning?
Loose money is raising the risks. As well as encouraging spendthrift governments, businesses have also binged on debt. As a share of GDP, US corporate debt levels are now close to where they were before the great recession. Yet investors are so desperate for yield that they are happy to extend cash to risky borrowers. “More money is going to be lost by more people reaching for yield… than all the theft and fraud combined in the last 50 years,” says John Mauldin in his Thoughts from the Frontline newsletter. What is clear is that by driving rallies in the kinds of financial assets that the rich disproportionately own – stocks and bonds – QE has stoked wealth inequality within Western societies.
What will central bankers do next?
The hunt is on for alternatives to QE, of which Larry Fink’s suggestion is only one. As Eric Lonergan puts it in the FT, one proposal is for central bankers to simply give people money, perhaps in the form of a direct transfer into everyone’s account. Another route to the same end is a “dual interest-rate” policy that sees savers given high rates and borrowers lower ones, with QE funding the difference. Yet attempts to buy up stocks, or even give people shopping vouchers, have already been tried in Japan, the country that pioneered ultra-loose money. Japan’s experience shows that for nations that fall into the trap of ultra-loose money, the outcome is not a dramatic crash, but decades of slow growth, anaemic inflation and eye-watering levels of debt.