Preparing for the Post-QE World
Over the past eight years, the major central banks have increased their balance sheets to $18 trillion from $6 trillion, predominantly through the purchase of their own government’s bonds. While the Fed has ended its QE program, the European Central Bank and Bank of Japan continue theirs. But those too will eventually come to an end. What happens next will determine whether the world economy is set on a path to real growth or further stagnation.
"Unwinding" these positions -- even progressively as the acquired assets mature -- would almost certainly create deflation and a financial crash as it would lead to the withdrawal of massive amounts of liquidity from the financial system. Instead, we are likely to see what Adair Turner, the former chairman of the U.K.’s Financial Services Authority, recently called a state of “permanent monetization.”
Permanent monetization may be inevitable, given the risks and difficulties entailed in undoing the asset accretion that happened under QE. It can prove beneficial, too. Since central banks are ultimately owned by governments, absorbing the QE purchases would effectively mean that governments would own their own bonds, assets that comprise a significant share of national debt.
Recognizing this changes the national debt picture. The newly consolidated national debt will be markedly lower once the assets acquired by the central banks through QE are subtracted; indeed, debt would stand at historically acceptable levels, as the table below shows:
What is essentially an accounting change would mean that governments would have greater scope to launch fiscal stimulus than previously anticipated. A large-scale stimulus program focusing on infrastructure and boosting human capital would likely trigger a world economic recovery. It would allow the benefits of QE to accrue to society as a whole rather than to the few owners of QE-inflated financial assets.
But there are risks as well. Permanent monetization assumes that the assets purchased through QE will never be settled by the debtor, the governments that issued them. The whole purpose of independent central banks was to prevent governments from using monetary policy to fund its expenses or its debt, so-called monetary financing.
Absorbing rather than unwinding the QE purchases would de facto remove that artificial separation and raise the question of whether future debt financing would occur the same way. This could breach the trust the public still place in fiat currencies, encouraging the hoarding of savings in alternative assets as opposed to the financial system.
Governments and central banks must find a way to realize the benefits of the money that has been created, without jeopardizing the ability of central banks to keep QE as a credible tool for the future. One way to do this would be to place the assets purchased by the monetary authorities under QE into a sovereign fund rather than allow them to be transferred onto the government’s books directly. This would clearly establish the current situation as a one-off and deprive future governments from any hope of gains from further quantitative easing.
Political momentum is building for some kind of exit from QE, as has been evident from German criticism of the European Central Bank but also the U.K. prime minister’s speech to her party conference last week. “While monetary policy with super-low rates and quantitative easing have provided emergency medicine, we have to acknowledge some of the bad side effects. People with assets have got richer, while people without have not,” Theresa May said. “A change has got to come, and we are going to deliver it.”
The change may be coming anyhow, as central banks run out of effective ammunition. That should be a signal for governments to do more. The good news is that they have more room than previously assumed.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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Jean-Michel Paul at JPaul@acheroncapital.com
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