Back in the spring, Ben Bernanke told the world that “tapering” would start “later this year”. The Federal Reserve Chairman was indicating, in other words, that America’s central bank would start to wind-down its $85-a-month money-printing habit by the end of 2013.
Such an outcome now looks increasingly unlikely. My view, in fact, is that the Fed, could soon unleash more, not less, quantitative easing – ramping up the policy rather than tapering. Such an outcome, were it to happen, would be incredibly risky. Speeding up monetary stimulation, rather than slowing it down, could spook financial markets – and even cause a panic. Yet in recent weeks, I’ve heard several well-placed economists and policy-makers, especially in the US, start to contemplate such action.
Angst-ridden investors and politicians generally love the funny money. When the big central banks create virtual cash, it tends to end up in asset markets, giving share prices a boost – resulting in bigger City and Wall Street bonuses. The Fed and the Bank of England use the QE money to buy sub-prime junk and government debt, which also helps busted banks look less insolvent. Ministers, too, can keep borrowing thanks to newly-created money, without bond yields spiraling out of control – so allowing them to dodge the really tough fiscal decisions. Why risk short-term unpopularity when you can just reach for more QE?
Given how much its helps our political and financial “elites”, then, QE has grown like topsy. Since “extraordinary monetary measures” began following the Lehman Brothers collapse in late 2008, America’s central bank balance sheet has tripled. Within the Eurozone, despite Germany’s initial aversion, the European Central Bank is catching up fast. Yet Britain is in a class of its own – the winner, if you like, of this global ugly contest. Since March 2009, we’ve quadrupled our central bank balance sheet – so much so that the Bank of England now owns no less than one third of all outstanding UK government bonds.
It wasn’t meant to be like this. When the Fed launched QE, this policy experiment was supposed to be limited to an ex nihilo monetary injection of $600bn. Even if the tapering had started in September, as was widely expected, the total would have topped $4,000bn by next spring.
But tapering didn’t start in September, of course. That’s because when the Fed suggested back in the spring that it might, the markets reacted badly – like an addict contemplating a “cold turkey” removal of their fix. Between May and August, yields on 10-year US Treasuries almost doubled, from 1.5pc to 2.9pc, with investors bidding down T-bill prices as they wondered who, if not the Fed, would buy Uncle Sam’s ever-expanding pile of government IOUs.
That led to fears that the resulting rise in market interest rates would upend America’s fragile housing market and choke off the broader recovery. This “financial tightening” caused by Bernanke’s taper-talk, together with the uncertainty linked to “debt-ceiling” rows in Congress, was enough to convince the Fed and the White House that the beginning of the end of QE should be pushed further into the future.
As such, the new market consensus is that tapering won’t start until January 2014 at the earliest – a belief that has helped push US share indices to new highs, with the S&P500 ending last week up no less than 23pc since the start of the year. Were tapering to begin in early 2014, America’s QE would amount to around $4,500bn – a jaw-dropping 7 and a half times’ the original estimate.
Just beyond the mainstream, though, there’s a growing view that QE could continue at its current rate for even longer – until, say June 2014. That would bring the QE total, including the subsequent taper, to some $5,000bn, equivalent to more than 30pc of America’s annual GDP.
Last Wednesday, at its monthly meeting, the Fed’s monetary committee voted to keep QE going – ordering the purchase of another $40bn of mortgage-backed securities and another $45bn of Treasuries, so $85bn in total. While the wording of its statement was very close to that of the month before, one key sentence was removed.
In its September statement, the Fed had said that: “the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market”. In the October minutes, that sentence was gone – causing some to argue that tapering is now more likely, because the economy is improving. Yet, the only reason “that tightening of financial conditions” has gone is because, since early September, when it lost its nerve, the US central bank has stopped talking about tapering. This illustrates the Fed’s Catch-22. If Bernanke starts preparing the world for tapering again, yields will start to spiral, choking off recovery and robbing the Fed of its resolve to taper. So US policymakers are caught in a trap – a seemingly inescapable dilemma that stems directly from the massive scale of QE.
These issues will come to a head, and in full public gaze, during Congressional hearings into the nomination of Janet Yellen as Bernanke’s replacement. Hand-picked by President Obama, the confirmation of the current Fed Deputy Chairman to the top job would, under normal circumstances, be a formality. Yet QE, previously so popular on Wall Street, is increasingly unpopular, on Main Street. Surveys show that voters now worry that the Fed is courting inflation. Having boosted asset prices, QE has conversely crushed deposit rates, so is penalizing ordinary savers. Bernanke is due to step-down at the end of January – in less than 3 months. Yet so politicized and sensitive has the Yellen confirmation process become, and so frantic the backroom negotiations, that no date has yet been set for these crucial Congressional hearings – although they’re expected around the middle of this month.
It may be that, as a parting shot, Bernanke does start the tapering process just as he leaves the Fed. Yet it strikes me that it is now more likely, given the relative weakness of America’s recovery, that QE continues at full-pelt at least until March or April next year, and perhaps longer.
The danger would then be that investors, finally, would be forced to face reality and openly question the effectiveness of QE as a policy to stimulate genuine economic growth. The virtual printing-presses have been running for over 5 years now and, still, the Western world remains in an economic malaise.
The longer QE goes on, the higher the chances that our central banks come under even more political pressure, which they’re powerless to resist, to turn up the funny-money dials further. That could be the moment when the mask slips and investors “head for the hills”, causing share prices to snap back and bond yields to soar.
We could then see the likes of the Fed and the Bank of England get heavily leant on to simply retire – or cancel – the government debt they owe. Already, “respectable” economists are lining up to float “infinite QE” and “making the unconventional conventional”.
Straight monetization of government debt is an economic taboo – and taboos exist for good reason. If we break them, we mutate natural systems and cause serious long-term harm. Cancelling government bonds bought by central banks will take us back to the bad old days of 1970s-style inflation and economic mismanagement. Yet this ghastly outcome looms increasingly large as the Western world’s central banks look to escape the trap that they themselves have laid.