A clear feature of the credit crunch era has been the advent of Quantitative Easing on a grand scale. Beforehand only the Bank of Japan of the major central banks had dipped its toe into that particular lake but now the list gets ever longer. This year has seen the European Central Bank join the party in terms of scale (previous efforts being much smaller) and also more and more similar moves in China as it tries to deal with its own slow down.
Also the countries which were earlier players in this particular game have found themselves unable so far to reverse what they have done. Readers of my blog will recall that from the early days I argued that central bankers had no exit strategy and that is how it has turned out. Only on Thursday I pointed this out in respect of the Bank of England which announced this..
the Committee agreed to re-invest the £16.9 billion of cash flows associated with the redemption of the September 2015 gilt held by the Asset Purchase Facility.
So it is stuck with the same £375 billion stock of QE and in fact is extending the maturity of it in a “QE Forever” way ( the last such effort saw a Gilt maturing in 2068 purchased ) which is similar to what is happening in the United States. This has been labelled under the banner of Operation Twist. Bank of England Governor Mark Carney was rather vague about the exit strategy last week showing that it is a can which has been kicked to some indeterminate date in the future. Waiting until interest-rates rise has first the issue of when will they? But also as they rise so probably will yields as we look to sell Gilts. So much for market awareness!
Is it a type of junkie culture?
My argument on this is two fold and let me open by pointing out something which is often forgotten using a chart provided by RBS.
Anybody spot a trend here?! One way of considering QE is central banks trying to continue the sequence of “hits” we have been getting. Another is that they felt under pressure to “do something” and it was there. This of course ignores the fact that the record of the country which had tried it (Japan) was between poor and disappointing.
If we look at the chart again there is a begged question over such a policy of trying to reduce bond yield which is that the trend line will need to go below zero. That is just the UK experience and we have seen Germany and Switzerland in particular actually do so especially at the opening of this year.
What good has it done?
This is rather patchy as even in the case of bond yields it is not clear-cut. Yes they are lower overall but there are other reasons for that to take into account. In general we have an expectations effect which reduces yields but as often as not the reality sees them edge higher in a type of “overshooting” described by Rudiger Dornbusch back in 1976. The purchase of mortgage-backed securities in the US seems to have boosted the housing market but in the UK higher inflation eroded real wages and was a downwards effect. So but for the sums involved one might say “meh”.
If you want a sub-plot of the recovery I noted that other day a report which pointed out that all 15 OECD countries which had raised interest-rates post credit crunch have since cut them again. Not much of a general recovery there!
However one pretty clear winner has been equity markets and one example is the US S&P 500 which fell to a closing low of 734 in January 2009 and is now 2077. Abenomics in Japan helped push the Nikkei 225 from around 8,600 or so back when it was expected to around 20,800 now.
That is the problem which is that the financial economy has benefited with markets higher and QE has kept banks going even if these days they are like vampires on life support. But the clear-cut economic effect has been much less sure and of course we have the image of rentiers and indeed the 0.1% benefitting but what about the rest of us?
Step Forwards QE For The People
The problem posed by QE looking to have benefited large investors rather than the ordinary person or indeed economies has led to considerable dissatisfaction. Along the way there have been suggestions of QE being adjusted to provide a direct benefit by using the funds to buy real things rather than financial assets. Usually this has meant suggestions of infrastructure investment.
In the UK we have this evolving as Labour party leadership candidate Jeremy Corbyn adopted to ideas mostly previously put forwards by Richard Murphy.
One option would be for the Bank of England to be given a new mandate to upgrade our economy to invest in new large scale housing, energy, transport and digital pro- jects:
Quantitative easing for people instead of banks.
The description of what this means from Richard Murphy is unwieldy but let me extract the meat from it.
People’s quantitative easing is instead a highly directed process where the debt that is repurchased has been deliberately created and issued either by a green investment bank or by local authorities, health trusts and other such agencies for the specific purpose of funding new investment in the economy.
That is debt monetisation in just about its purest form. What I mean by that is the Bank of England will be buying debt which has been specifically created for that purpose. As we stand it has kept its distance from that and has bought general bonds and also not bought them at issue
Who will do the investing?
I suspect I am not the only person breathing a sigh of relief at the thought it will not be the Bank of England! Here we do get a problem in a world where we have “ghost cities” in China and Ciudad Real airport in Spain which cost over 1 billion Euros and was just sold for 10,000 of them. In the UK we have the plans for HS2 rail project about which the only certainty is that it would be extremely expensive.
The Financial Times provides some support but if you read the sentence below what it is actually telling us is that if it works it will work!
If Corbyn’s preferred investments are useful, they could help restore some of the lost ground in productivity and lead to higher real wages for Britons.
So if they are not useful it will not work?! As ever I prefer to avoid the politics but we are on familiar ground for my analysis as we need to consider what is output and how good a guide GDP is. I fear what politicians would do with a “green investment bank” for example as cases in the past such as the National Enterprise Board had more vanity projects than successful ones. Concorde was a stunningly beautiful plane which looked glorious in the air but it was an economic failure. Also the “greenwash” of such issues is intriguing if we compare it to the usual reality of projects such as an unused airport which could not be much less green.
Do you need the Bank of England at all?
As the UK can borrow extremely cheaply right now do we need the Bank of England to buy the debt? After all you could issue thirty-year debt at a yield of 2.5% so why not do that? After all if a project cannot generate some 2.5% a year as a return it seems to be weak in the first place.
What about inflation?
We are assured that there will not be any. From Richard Murphy.
Third, printing money is not inflationary when there is a shortage of money in the economy.
Yet previous QE efforts are critiqued on these grounds.
Instead it flowed into the house price and asset speculation.
Whilst it is missing for the headline inflation numbers, that sure looks like inflation to me! As the economy is growing the danger is that such projects see cost overruns and are badly managed and the spiral begins again.
Also there is the technical issue of debt monetisation and the effect on the exchange rate. The nearest case to this I have looked at in the credit crunch era has been Ghana where the Cedi dropped like a stone and generated considerable inflation. Now to coin a phrase we are not Ghana! But that does not mean that some of that would not affect us and we know from Russia,Brazil and Ukraine that it is a tough nut to crack once it starts.
The concept of “People’s QE” opens favourably both emotionally and on the grounds that it looks to move away from the financial economy to the real one. However the next part is the issue of how successful this sort of command style effort in an economy is.? I am sure that everybody reading this can thing of worthwhile projects that are viable at the current ultra-low bond yields around. If we skip over the bit as to whether that needs Bank of England involvement we have the issue of whether you believe that politicians will wholly or at least mainly invest in them. In the past that has not gone so well and that includes the recent past. In the UK a lot of this seems to involves the railways which have been a problem child whatever solution has been tried and involves the belief that they are the future. I have my doubts and will be interested in what readers think on that.
Moving onto other issues then we have a potential direct inflationary impact in a growing economy plus a possibly stronger effect if the exchange rate us affected adversely. In the UK the latter effect has been a strong one over time. As to the Bank of England it would make its loss of independence more explicit and it would be a question of what would happen should the Gilt market hit difficult times of the sort our economic history has had no shortage.
One thing we do learn is a reinforcement of one of the themes of this blog. The lyrics below seem to be as appropriate for QE as they are for Greece and the Euro.
You can check-out any time you like,
But you can never leave!