Future historians will see QE as a mistake
“The final word on quantitative easing will have to wait for historians,” wrote Ambrose Evans-Pritchard last week. Now the US Federal Reserve has apparently ended QE, I’d like to take a cue from my esteemed Telegraph colleague by suggesting what future historians might say.
Last Wednesday, the Fed terminated QE3 – the latest incarnation of its money-creation programme. The American version of this highly unorthodox policy began in late 2008, with the Fed creating virtual balances ex nihilo and purchasing assets such as government debt and mortgage-backed securities, often from bombed-out banks.
The US authorities originally billed QE as a $600bn exercise. By unlocking frozen interbank markets, it was supposed to spur growth, breaking the credit crunch. As meaningful recovery remained elusive, though, QE2 was launched in 2010, with its successor two years later.
In sum, the world’s most important central bank has fired $3,700bn from its monetary bazooka. America’s QE has been six times bigger than envisaged. The Fed’s balance sheet has grew more than three-fold in just over half a decade – an unprecedented monetary expansion. And it’s not just America, of course.
Launched in March 2009, British QE was presented as a £50bn program. It has since ballooned to £375bn, some 7.5 times the official prediction. The Bank of England’s balance sheet has quadrupled, with our QE focussing on gilt purchases. The Bank now holds over a third of all outstanding sovereign bonds.
Ordinarily, governments borrow from pension funds, insurance companies and other long-term investors. As UK state spending has surged over recent years, with our national debt doubling to £1,400bn since 2008, we’ve kept our public finances afloat only by effectively selling government debt back to the state, using newly-created money. If that sounds like dubious circular financing, that’s what it is. Future historians will no doubt discuss this uncomfortable reality more than we do today.
When the sub-prime crisis emerged, Eurozone policy bosses dismissed it as “an Anglo-Saxon problem”, claiming the European Central Bank wouldn’t need to use “extraordinary monetary measures” in response to “America’s credit crunch”. In reality, eurozone banks were also deeply exposed, having invested just as recklessly as their Anglo-Saxon counterparts.
There has been eurozone QE, despite what you often read, but it’s been largely hidden behind technicalities, in part to placate inflation-averse German voters. The ECB’s balance sheet has more than doubled since 2009. And, now the Fed has “ended” QE, we can expect the ECB to grab the Western money-printing torch anew, even if its efforts are kept relatively low-key as part of an on-going PR sop to Berlin.
It strikes me, then, that future historians will have a serious problem with QE, not least in terms of scale. Six years ago, during the dark days following the Lehman collapse, I agree that emergency measures were needed. Global markets were tanking. Politicians (and police chiefs) were scared. Yes, the too-big-to-fail banks (and asleep-on-the-job regulators) were largely to blame. But no purpose would have been served, and huge social and commercial strife would have resulted, from a fully-blown banking collapse.
So some QE was justified, providing a crash-pad for a seriously over-stretched Western financial sector. Yet rather than using the room for manoeuvre provided by early QE to address the underlying issues, closing down ruined banks, merging them stronger competitors while wiping out shareholders and protecting depositors, massive monetary expansion was used to mask problems instead.
Far from forcing weak banks to come clean and fully disclose the true state of their rancid balance sheets, which would have been the proper way to run a capitalist economy, QE was extended again and again, drip-feeding zombiefied financial institutions, keeping them on life support. This was a major mistake. Far from re-booting wholesale money markets, providing the finance to drive renewed economic expansion, QE spiralled out of control, continually diverting resources towards continued “mal-investment” as large Western financial institutions were hosed-down with central bank liquidity.
As such, a necessary emergency measure morphed into a deeply counter-productive comfort blanket. By rigging sovereign bond markets, QE has helped Western governments avoid tough fiscal decisions. By shielding banks from the reality of their bad investments, it’s also exacerbated too-big-to-fail and made another crash more likely. While QE 1 was defendable, QE2 and QE3 will in my view be judged as historic mistakes.
Future historians are also likely to focus on QE’s unintended consequences. While some of the central bank funny money has sat on the balance sheets of busted banks pretending to be solvent, much of the rest has found its way into asset markets – equities, famously, but also tangible assets.
Since 2009, QE has undoubtedly pushed up oil prices, further stymying Western recovery. Combined with poor harvests, it also bid-up soft commodity prices, helping to explain the mid-2010 food price spike, which in turn seriously aggravated the Arab Spring.
In late 2010, Guido Mantega broke diplomatic ranks by accusing the West of conducting “currency wars”. One of QE’s aims, the Brazilian Finance Minister boomed, was to drive down the dollar, pound and euro to “steal competitive advantage” from the rest of the world and debase the “hard currency” debts increasingly owed by Western government to their big emerging market counterparts.
While Western governments routinely deny deliberate debasement, future historians will judge. Certainly, the emerging giants have taken umbrage, returning fire by starting to sell Western sovereign debt. They’re also fighting back with tariffs, export subsidies and other trade barriers. Across the world, East-West protectionism is rising fast and QE is partly to blame.
Unintended consequences closer to home include more Western inequality – as QE has boosted equity prices, while hammering ordinary savers (not least pensioners recently forced to annuitize). The flip side of savers’ low interest-rate pain, of course, has been a massive wealth transfer to bailed-out banks. QE has been an umbilical cord of free money to the financial behemoths that did much to trash our economy. That tears at the social fabric.
Humbug, some readers will cry, claiming that QE hasn’t had the inflationary impact some said it would. Really? From late 2009, UK inflation went above the Bank’s 2pc target and stayed there for 4 years. Price pressures have driven the deepest fall in real wages in living memory. And much of the inflationary impact may be yet to come.
While QE expands “base money”, the overall money supply in a modern economy is largely determined by bank lending. Once the economy returns to normal, and full bank confidence is restored, there’s a widespread view our vast base money expansion will generate sustained high inflation – not least as Western governments would find that rather convenient as a way of eroding our spiralling state debts. Again, future historians will know the answers better than we do today.
So, while my colleague Ambrose has taken a more forgiving view of QE than me, he’s exactly right that it’s far too early to truly judge the impact of what amounts to a huge monetary experiment – not least as the much-discussed “unwind”, the reaction of pumped-up equity and bond markets when vast Western money-printing finally stops, could yet be explosive.
I’ll take a punt, though, and venture that future historians will wince when they examine QE. This policy, to the massive extent we’ve used it, has been unwise and unjust, harming Western electorates and souring relations with the increasingly powerful non-Western nations upon which our future prosperity depends. I’d also venture that, not only in the Eurozone and Japan, but even in the US, there’s a lot more QE to come.