Quantitative Easing is "like heroin"
Former Permanent Secretary to the Treasury from 2005 to 2016, Nick Macpherson, said yesterday, that it was time to move on from Quantitative Easing (QE), and that QE was like heroin: “need ever increasing fixes to create a high. Meanwhile, negative side effects increase. Time to move on.”
Macpherson’s comments were in response to Rupert Harrison’s claim that the European Central Bank (ECB) would be in a “car crash” situation if it stopped its QE programme. But what began as a remedy or a quick fix, it has now become a normalised practice, that has exacerbated inequality, boosting the wealth of the few and punishing low-income savers.
Lord Macpherson’s comments come at a crucial moment, as central bankers are pressurised into winding down their QE programmes that helped the economy recover since the 2008 financial crisis. Particularly, all eyes are on the upcoming annual Jackson Hole Economic Policy Symposium in Wyoming on 24-26 August, which will be hosted by the Federal Reserve Bank of Kansas City and attended by representatives from central banks of more than 40 countries. Strategists are specifically watching for remarks from European Central Bank president Mario Draghi on the Eurozone monetary policy, its QE and any changes of the bank’s low interest rates.
The €2tn bond-buying programme of the ECB might need to wind down by next year, as the eurozone economy is improving and the central bank is running out of bonds to buy, the Financial Times highlighted yesterday. According to the ECB’s rules, the bank is allowed to purchase a third of each country’s debt and it has almost reached its purchase threshold with German Bunds and Portuguese debt. Germany, for example, has gross government debt of €2.1tn and the ECB has purchased more than €400bn of bonds. The ECB has reached its purchase limit of other European countries’ debt such as that of Portugal, Holland, and Ireland. With the supply of bonds declining, many fear that the ECB might be risking too much if it has no other option but to reduce its stimulus programme too soon.
Consequences of QE
While the aim of QE has been to reduce the negative effects of an economic recession, the long-term effects have often been downplayed or ignored. Jean-Michel Paul of Acheron Capital, in an article on Bloomberg, highlighted the unintended consequences of QE, which “saw major central banks buying government bonds outright and quadrupling their balance sheets since 2008 to $15 trillion.” One of these consequences is asset inflation. Like consumer inflation, Jean-Michel Paul pointed out that asset inflation is similar. Asset inflation—when the price of assets such as real estate, shares, etc. rises faster than the rate of economic growth—is usually caused by low interest rates, enabling investors to borrow cheaply without receiving a good return on their bonds. Jean-Michel uses as an example the so-called zombie companies: companies that are in debt, and which are able to pay the interest on their debts but not the principal debt itself. In this sense, they are like zombies, kept alive and fed by banks so that they continue to operate.
Like any contemporary configuration, there bound to be those who win and those who lose. On the one hand, the losers are “the aging middle class, who, in order to maintain future consumption levels, will now have to increase their savings. Indeed, the savings made by working people on stagnant wages effectively generates less future income because investable assets are now more expensive.”
On the other hand, the winners are obviously the wealthy “people with savings at the beginning of the process, who saw the nominal value of their assets skyrocket,” and the state “which now owns through its monetary authority, a large part of its own debt, effectively paying interest to itself, and a much lower one at that. For when all is accounted for, asset inflation is a monetary tax.”
Jean-Michel Paul proposes that the QE’s disruption and negative effects can be dealt with if governments are willing to channel their gains to “true economic wealth creation and redistribution,” funding education and infrastructure. This argument has been made before, when Rick Rieder, global chief investment officer of BlackRock, said in December 2016 that the ECB should avoid continuing its QE programme and retool it to fund infrastructure, putting money directly into the economy. Yanis Varoufakis, the former finance minister of Greece, has also praised this idea as a way to reshape the banking system, inject confidence back into companies by spending in the economy.
Perhaps, to return to Macpherson’s drug metaphor, the problem is how to withdraw completely from the QE’s addiction, without shocking the economic system. Creative solutions such as those proposed by economists might be a realistic and productive way to rehabilitate the banking system in the long run.