Market analysis: Quantitative easing close to wearing out its welcome
Opposition to quantitative easing (QE) and unconventional monetary policies appears to be growing.
A story last week cited an informal consensus among European Central Bank officials over tapering QE gaining prominence. In reality it is unlikely that this is close to being considered, but the way that the story affected the market, pushing the euro higher, showed that it struck a chord and is in tune with the developing mood.
The Bank of Japan resisted the pressure to cut interest rates further into negative territory last month, and having left monetary policy unchanged in September the Federal Reserve is again back to talking up the prospect of higher US interest rates as economic data improves again.
The Bank for International Settlements has long been something of a lone voice in criticising the maintenance of unconventional policies, and last month wrote in its Quarterly Review that monetary policy is becoming “overburdened” and a potential threat to financial stability.
Now the IMF is warning that a record US$152 trillion of debt – 225 per cent of global GDP – poses a threat to the global economy. Ultra-easy policies have created excess leverage, periodic periods of illiquidity and yield-chasing behaviour. Investors recognise the risks as well, especially with regards to the impact of negative interest rates, which have had the effect of converting trillions of dollars of bank “assets” into “liabilities”, damaging the profitability of financial institutions.
Last month Janus Capital’s Bill Gross wrote that “central bankers are threatening the engine of the economy by keeping interest rates too low now for too long”, and this month he went further describing central bankers as being like gamblers, and concluding that “this cannot end well”.
This critique was given more academic underpinning last week by professors Charles Goodhart and Geoffrey Wood, who argued that rather than providing a spur to inflation, QE simply recycles money between the central banks and financial institutions in a sort of “monetary roundabout”.
The argument is that cash simply remains in financial institutions, never actually entering the real economy as intended to exert upward pressure on inflation. Instead, such funds remain deposited with central banks such as the Fed that pay interest on cash deposits, with cash effectively going back to its point of origin and/or inflating the price of financial assets.
Furthermore, because of declining profit that banks can realise from their loan “assets”, lending has declined, with cross-border lending being a significant casualty. This has put further weight on global credit expansion and has increased segmentation between the markets within countries, particularly in the euro zone, where such behaviour means that cash does not trickle down to its intended targets.
In short, QE has weakened the profitability of financial institutions and has reduced the desire or capability of banks to lend. Rather than the solution, QE may be contributing to the problem, with Mr Goodhart and Mr Wood describing it as having now become “quite erroneous”.
Largely absent from this debate so far, however, have been politicians, who have been wary of entering into the post-financial crisis discussion about the role of monetary policy, which is perceived to be the domain of central bankers.
In a world of independent central banks, politicians have seen their influence as being restricted to fiscal policy, which until recently has also been seen as off limits because of a number of other factors. This may be about to change.
There are perhaps the first signs that politicians are getting restive with the current situation. The US presidential candidate Donald Trump has notoriously been highly critical of the Fed’s monetary policy, but more interestingly, conventional political leaders are also becoming critical.
The British prime minister Theresa May last week gave a speech in which she said that “while monetary policy – with super-low interest rates and quantitative easing – provided the necessary emergency medicine after the financial crash, we have to acknowledge there have been some bad side effects. People with assets have got richer. People without them have suffered. People with mortgages have found their debts cheaper. People with savings have found themselves poorer”.
This sounds like a not very coded criticism of the Bank of England, which has retained the option to cut interest rates further recently. With elections in major countries in Europe and the US in coming months, expect such voices to grow louder.
Tim Fox is the chief economist and head of research at Emirates NBD.
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